WHITE PAPER THE IMPORTANCE OF DIVIDENDS TO TOTAL RETURNS THE IMPORTANCE OF DIVIDENDS TO TOTAL RETURNS On new year’s eve 1999, the FTSE 100 index 1999, the FTSE 100 Total Return Index stood at Basically, price fluctuations have of the UK’s largest companies stood at a 12,447. On 9th March 2020, even after a 7.7% peak of 6,930.2 We were at the height of the one-day fall, one of the largest ever, it stood only one significant meaning for internet boom and any business with ‘dotcom’ at 22,144 – a 78% rise2. Over 20 years, that in its name was likely to be amongst the most equates to an average annual return of 3% – not the true investor. They provide him sought-after stocks in town. Few would have overly impressive, but, unlike deposit invest- contemplated that, a little over 20 years later, ments, you would still have beaten inflation… with an opportunity to buy wisely the index would be lower. And yet here we are: and it’s certainly rather more comforting than a at the beginning of August 2020, the FTSE 100 circa 20% loss. Clearly, it’s dividends that have when prices fall sharply and to sell is hovering around 6,0002 – albeit in unprec- come to the rescue. edented circumstances as markets come to wisely when they advance a great terms with the far-reaching impact of the DIVIDEND YIELDS AND TOTAL RETURNS COVID-19 coronavirus pandemic. – WHAT ARE THEY AND HOW DO YOU deal. At other times he will do CALCULATE THEM? better if he forgets about the stock It’s been a brutal few months. With the market down some 20% off its all-time peak in mid- A dividend is the distribution of a portion of 2 market and pays attention to his January , it is far from difficult to appreciate how a company’s earnings to its shareholders. A those who question the risk/reward equation of monetary amount per share, it is referred to as dividend returns and to the operat- equity investment might feel somewhat vindi- a dividend ‘yield’ when expressed as a percent- cated. Indices, when looked at in isolation, don’t age of the company’s share price – for example, ing results of his companies. paint a particularly accurate picture however. a business with shares priced at £100 making A purely one-dimensional analysis of this kind a dividend payment of £5 is said to have a yield is fatally flawed for the simple reason that the of 5%. Benjamin Graham, widely known as the ‘father of value investing’1 index doesn’t deliver long-term investment returns – for that, one needs to look at the total When deploying capital in order to optimise the return, of which a fundamental component is utilisation of cashflow, a business proprietor will dividends. typically have five options: Total return indices do exist but oddly, despite ● invest in existing operations the fact that they deliver a much more reliable measure of overall investment returns, are not ● acquire other businesses widely publicised. Unsurprisingly, on reviewing ● repay debt the performance of the FTSE 100 on a total ● repurchase their own stock return basis over the last 20 years, the picture looks markedly different. On 31st December ● pay dividends. 1 Source: B Graham, The Intelligent Investor, 1949 2 Source: FTSE 100 Index 2 3 They could, of course, simply leave period of time, simply take your total investment gains surplus cash on the balance sheet, but (in our example, £155), divide it by the original value a business seeking only to compound of the investment (£1,000), and multiply by 100 to its cash is likely to see its longer-term convert it to a percentage. growth prospects severely compro- mised. Shareholders clearly don’t invest Reinvesting dividends to buy more shares enables in companies to be a deposit account you to benefit from the effects of compounding … or over the long run, and will subject what Einstein called the “eighth wonder of the world”. them to a return expectation somewhat In the mid-1990s, Ronseal – higher than the prevailing savings rate. THE APPEAL OF DIVIDEND INCOME Dividend payouts are therefore a way of a UK wood-stain and wood-dye rewarding those long-term shareholders Understandably, many investors are attracted to for the risk premium of holding a income-paying stocks simply because they have manufacturer – became famous for company’s equity. a basic need for the yield, particularly in a period its television advertising, and par- of record low interest rates – retirees would be the Total return is a straightforward measure obvious example. Whilst not as reliable as fixed ticularly for its slogan – “It does ex- of the overall return from an investment income investments such as bonds, dividend-pro- – for shares, it comprises the combina- ducing stocks can be quite valuable in this regard. actly what it says on the tin” – to the tion of capital gains through increases An obvious consequence of this, however, is that the extent that it became a common in the share price with income gains investment power of dividend-paying stocks has been through dividend payouts, and assumes overlooked, almost to the point where they might be idiomatic phrase, meaning that those dividends are reinvested. considered boring, despite the fact that the effect of Again, a simple example may prove dividends on equity portfolio returns has not dimin- that the name of something is an helpful. ished for decades, even centuries. accurate, rather than a grandiose You buy 100 shares at £10 per share; In the mid-1990s, Ronseal – a UK wood-stain and or overstated, description of its at- the initial value of your investment is wood-dye manufacturer – became famous for its therefore £1,000. If the company pays a television advertising, and particularly for its slogan – tributes. In that sense, dividend-pay- 5% dividend, you’ll receive £50, enabling “It does exactly what it says on the tin” – to the extent you to acquire five additional shares. 12 that it became a common idiomatic phrase, meaning ing stocks are the Ronseal of the months later, the share price rises from that the name of something is an accurate, rather investment world. £10 to £11. than a grandiose or overstated, description of its attributes. In that sense, dividend-paying stocks are Based solely on the share price, your the Ronseal of the investment world. Arguably boring return is 10%. However, you now own they may be in the short-term but, when their contri- 105 shares, meaning your investment bution to long-term real returns is fully appreciated, is valued at £1,155 or 15.5% more coupled with their ability to mitigate the effects of both than you paid for it. That percentage inflation and challenging markets, they’re bordering represents your total return. In order to on the sexy! calculate your total return over any given 4 5 Let’s examine the appeal of dividend payers a manifest signs of its financial strength; it is un- little more closely. surprising that it remains a persuasive indicator S&P 500 Index Dividend Contribution to Total Return today. S&P 500 Index Price Only (No Dividends) First, dividends are paid from real earnings in hard cash and, as such, are a matter of fact Third, dividends can fulfil a critical role as a not conjecture. Put bluntly, companies that ‘bear market protector’ or cushion when, as 20% pay dividends are less likely to be indulging we’ve seen, markets are in decline, or when in ‘creative accounting’. Management teams they are stagnant because valuations are 30% 16% can be highly adept at making earnings look elevated and the upside potential is limited. 15% 28% good but, with a bi-annual dividend obligation This has been the case on many occasions, 17% to meet, sleight of hand of that kind becomes and often for protracted periods: for the first 15 rather more challenging. Dividends are overt, years of this century, the Nasdaq Composite 10% very public promises. Breaking those promises Index didn’t gain a single point for example. 42% 67% 44% is embarrassing to management, damaging to 5% share prices and largely seen as an admission The contribution of dividends to total returns 73% NA* of failure. fluctuates over time of course. The analysis annual total return Average on page 7 of the widely-followed US large cap 0% 1940s 1950s 1960s 1970s 1980s 1990s 2000s 2010s 1930- Second, the payment of dividends is one of barometer, the Standard & Poors 500 Index 2019 the most compelling ways for companies to (S&P 500) from 1930 to 2019, conducted by promote their financial well-being and to send US-based asset manager Hartford Funds, a potent message about future prospects and shows that for the period as a whole, the divi- Source: Morningstar/Hartford Funds, 02/2020. S&P 500 Index is a market capitalisation weighted price index composed of 500 widely held shares. performance. A willingness – and ability – to dend contribution averaged 42% which equates *Total return for the S&P 500 Index was negative for the 2000s. Dividends provided a 1.8% annualised return over the decade. maintain and grow dividends over time provides to 1.8% per annum on an annualised basis. clear evidence of strong fundamentals, solid Looking at the decades discretely, however, business plans, and a deep commitment to illustrates the extent to which that contribution During the 1940s, ‘60s and ‘70s – decades in which total returns were shareholder value. to total return varies.