The Dividend Investor. Rodney Hobson
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The accompanying website for this book can be found at: www.harriman-house.com/thedividendinvestor
Acknowledgements
Thanks for invaluable insights into how companies set and pay dividends are due to:
Paul Roberts, finance director, Wynnstay
Kulwant Singh, finance director, computer software supplier Delcam
Shatish Dasani, finance director, TT Electronics
Duncan Jeffery, marketing manager, Hargreaves Lansdown
and to Zoe Biddick and Katie Tzouliades of financial public relations company Biddicks.
Also thanks to Stephen Eckett of Harriman House for supplying extensive company data as well as for editing this book with his customary courtesy and perspicacity.
Why dividends?
There are two major reasons for investing:
1 to produce income
2 to store wealth for some time in the future.
It is very important to recognise the remarkable power of dividends. Newspapers feed the public with daily doses of how share prices rise and fall, often commenting on how billions have been added to or wiped off the stock market or how shares in some company or another have gained millions in a single day because of one item of good news.
It is easy to be seduced by these dazzling figures that foster the notion that the stock market is all about making a fast buck in a gambler’s paradise, especially in a bull market when all eyes are on rising shares prices.
In fact, the real money is made through solid investments that pay regular, rising dividends. The greater part of total returns for share investors over time will come from dividends, not capital gains. And when markets are falling, your only gains are likely to come from dividends.
To demonstrate the importance of dividends we can look at figures produced by the Barclays Equity Gilts Study, which showed that £1,000 invested in shares at the end of the Second World War would have been worth £57,210 by the end of 2009.
However, had we reinvested the dividends our pot would have ballooned to a massive £924,600.
So unless you are a very short-term trader, you should be investing for dividends as part of any strategy for capital growth. Companies paying gradually improving dividends are the ones that will see their share price rise over time and the income from dividends will help to offset any capital losses you may suffer.
Even short-term investors should consider running a separate long-term investment portfolio as a back-up. Therefore almost every investor should be a dividend investor.
It is possible to invest by putting your money into a fund such as an investment company or trust. You can find out how to do this in chapter 24. However, you are abrogating responsibility for your finances to a fund manager who cannot possibly know what you want from your investments and what risks you are prepared to take.
The performance of individual funds can vary enormously from year to year. The one constant is that the manager has to be paid out of your money. There is absolutely no reason why you cannot make sensible investment choices yourself, retaining control of your own destiny. Even if you do not perform quite as well as the fund manager, you will come out ahead because you are not paying the fund’s fees.
With the help of this book you can compete easily with the City professionals, retaining the flexibility to invest as, when, and where you choose.
Chapter 1. Companies and Dividends
The purpose of companies – to pay dividends
Let us be quite clear: the whole purpose of companies is to pay dividends. It goes like this:
1 a company is set up
2 the company makes a profit
3 the owners share the profit
4 we all live happily ever after.
The payment of dividends is, or should be, the raison d’être of all companies whose shares are quoted on any stock exchange. Dividends are the reward paid to shareholders who have invested their money in the business.
Yet in a sense dividends come last in the pecking order. They are funded out of what is left over after a whole range of bills and obligations have been met, such as:
staff wages
trade creditors
tax
interest and repayments on bank loans
pension fund contributions
bondholders
cash to meet day-to-day needs (working capital)
investment in the company.
There are two factors that affect whether a dividend is paid at all:
1 The company must have made a profit, either in the current or in previous years.
2 The company must have some cash to fund the dividend.
Companies do not normally pay out all the profits as they arise. Some cash is retained to fund the day-to-day operations of the company and some is held to fund expansion or new plant and machinery. Profits that are thus retained in the business build up in what are known as ‘distributable reserves’, so called because this is the amount of cash that can legally be distributed to shareholders in dividends.
If the company makes a loss, that will reduce the size of the distributable reserves. If losses persist and all the distributable reserves are used up, the company cannot pay dividends. Any accumulated losses must be fully offset by subsequent profits before the dividend can be restored unless the company receives permission from the High Court for a capital restructuring.
Cash is king
To emphasise, the company must actually have cash available to pay dividends. Profits on paper are no use in this respect. Your house may be worth twice as much as you paid for it but you cannot spend any of that gain unless you actually sell it. Similarly companies may make profits on paper, say from the revaluation of assets, but cash is king.
These rules apply to all companies, irrespective of their size or sector. You may find that companies with heavy capital costs, such as manufacturers and plant hire companies, build up larger distributable reserves to conserve cash. Companies with erratic profits will also want to keep sizable reserves so that they can maintain a steady dividend in good years and bad.
In contrast, companies with strong cash flow and low debts will find it easy to dish out the dosh.
Dividends can grow even in hard times
Total dividends paid by UK quoted companies actually grew in 2008, after the scale of the credit crunch had become only too apparent, to £67.1 billion from £63.1 billion in 2007. That is a lot of money for non-investors to be missing out on.
Admittedly, dividends were scaled back in 2009, to £58.4 billion, and again in 2010 to £56.5 billion. However, the fall in 2010 was entirely due to the suspension of BP’s dividend for the first three quarters of the year, according to figures compiled by Capita Registrars, which keeps the shareholder records of well over 1,000 quoted companies up to date.
Companies apart from BP increased their dividends by an average of 7.5% in 2010 as their shareholders received an early boost from the nascent economic recovery.
Even