Have We Gone Overboard On Equity Income?

Published in Investing on 25 April 2012

Is the case really so strong for dividend-paying shares?

When everybody agrees exactly where you should put your money, this is usually a good signal to put it somewhere else altogether.

That was certainly the case at the start of 2011, when every investment adviser was busily tipping emerging markets, which subsequently fell 20%.

It was also the case at the start of this year, when everybody agreed stock markets were best avoided, just before they set off on a snorting bull run.

So where does everybody agree you should put your money now? Into dividend-paying stocks. Investment analysts and fund managers are all talking up the power of the dividend. So is almost every single Motley Fool contributor, above and below the line. Frankly, so am I.

Surely we can't all be right?

The case for dividends

In these days of low stock market growth, rock bottom interest rates and continuing economic uncertainty, who wouldn't want to buy solid global blue-chip stocks paying handsome dividends?

Global blue-chips are sitting on a mountain of cash, yet recent stock market falls have left many trading at lowly prices. UK dividends soared 25% in the first quarter to hit a record high.

Investors can choose from plenty of juicy yields, starting with these five shares with rapidly rising dividends, while this dividend is up 198% in four years.

Better still, you can enjoy delightful dividends for a decade. No wonder David Kuo is looking so cheerful these days. He is collecting blue-chip dividends every month.

So am I, for that matter.

The bond across the pond

As you can see, there are plenty of great dividend opportunities out there. They look even more attractive when you consider the alternatives.

You could lend your money to the US government and be grateful to get a yield of 2% (and lose sleep worrying about the government bond bubble). Or buy a corporate bond and pat yourself on the back for getting 3% or 4%.

Or you can simply leave it in the bank and be grateful with 1%.

The real yield

Alternatively, you can buy a defensive blue chip such as GlaxoSmithKline (LSE: GSK) on a forecast yield of 5.1% and undemanding price-to-earnings (P/E) ratio of 11.9x for 2012. You might also get capital growth on top.

Or you could buy oil giant Royal Dutch Shell (LSE: RDSB) on a 5% yield and 7.6 P/E, and Vodafone (LSE: VOD) on a forecast yield of 7.4 and P/E of 10.9.

If you can stand the share price volatility, you can buy insurer Aviva (LSE: AV) on a forecast yield of 8.9 and P/E of 5.2.

Individual company shares are risky, of course, and look set for a difficult summer, but that shouldn't bother you too much if you are holding for five, 10 or 20 years, as I would recommend.

I own shares in all these companies and the dividends really to cheer me up. I could also tell you how I own units in equity income fund Invesco-Perpetual Income (current yield 3.8%), but I think you get the point.

Like everybody else, I dig dividends. And I haven't even mentioned that you might get capital growth on top as well.

So that's the case for. What about the case against?

Everybody's doing it

Before we get onto that, I want to share a piece of research from Capita that has just hit my inbox. It noted that recent sharp growth in UK dividends is "remarkable" given the collapse of the banking sector and BP's dividend suspension following the Gulf oil spill.

This only demonstrates just how healthy the remaining large UK corporations are.

The research also highlights the long-term glory of dividends. Somebody who invested £100,000 in a balanced portfolio of investments March 1993 and reinvested all their dividends would have £379,606 at the end of this March. That's an increase of 279%. During that time, inflation rose just 73%.

If that investor had spent all their income, their capital would still be worth £196,615, while their annual income would have risen from £4,100 to £7,400.

Capital growth and rising income. What's not to like? And that's at the end of a period when global equity markets faced their most challenging times since the 1930s.

If you're investing for the long-term, as you should be, the dividend is a very faithful friend.

The case against

You can see why everybody is so hot on dividends these days. There must be something bad to say about them. So here goes.

Well, your capital could take a knock, if the eurozone crisis continues to savage markets. Mind you, as a long-term investor, I would see that as a buying opportunity. For solid, high-yielding, blue-chip stocks.

I'm sorry. I couldn't help myself.

Sometimes the received wisdom just looks too damned, well, wise. If you're immune to the dividend story, tell me why below.

To learn more about dividend-paying shares, take a free 30-day trial to Motley Fool Share Advisor, where we recommend our top dividend share each month.

More from Harvey Jones:

> Harvey Jones owns shares in Aviva, GlaxoSmithKline, Royal Dutch Shell and Vodafone. The Motley Fool owns shares in GlaxoSmithKline.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

Dylantherabbit 25 Apr 2012 , 8:42am

What do Capita mean by 'balanced portfolio' ? Is a mix of bonds snd equity or is it 100% equity?

atalbot9 25 Apr 2012 , 9:49am

I agree in the dividend story to a certain extent, but I'd also encourage readers to take a step back and understand why/what it means to be getting a dividend. By this I mean it's a proportion of profits that the company is returning to shareholders, usually when the company is maturing. This is money that is not being reinvested back into the business in order to grow. If a company's dividend payout ratio is 100%, there is nothing to reinvest in which case, theoretically, profits would struggle to grow and therefore too the share price.

My point is that for a long term investment you should arguably be wanting the company to be retaining cash in order to invest and grow, rather than giving it back to you.

goodlifer 25 Apr 2012 , 10:00am

I too am a sucker for blue chip dividends at current prices.

If "everybody" thinks like us, why don't they cost more?

equitybore 25 Apr 2012 , 10:17am

For me, dividends are the way to go because I can add the individual shares (or investment trusts) to my SANE (sleep at night equity) collection. I know that whatever the market, the Kerching! of dividends will roll in month by month, to be largely re-invested where and how I want.

ANuvver 25 Apr 2012 , 11:35am

I'm sure Hannibalis will be along presently with something to say about being happy with 3-4% on corporate paper!

I don't think "everyone" is cock-a-whoop about dividends. There's a wall of money in sovereigns, and by no means all of it has to be for institutional reasons. Plenty of people still buy the concept of "safe" assets.

Interesting price reaction today - UK officially in recession again and the markets just shrugged and said: yeah, we know.

mcturra2000 25 Apr 2012 , 12:36pm

"Everybody's doing it"

There's a really good video of Sanjeev Shah giving a presentation at the Fidelity Special Values meeting. It's 30 min long, I like it a lot, and I hope Fidelity do more of these types of videos. http://bit.ly/IJSq1V

He was saying, as you yourself pointed out, that everyone seems to be positioning themselves in equity income shares. He doesn't like the consumer staples (food, beverages, fags) at all; saying that their ratings are the highest for 30 years.

His favourite sectors at the moment are media, financials, tech hardware and general retailers. He thinks there has been a convergence between high and low quality stocks, and thinks that quality growth ideas are undervalued.

Another argument against dividends is that when a divvie is paid out, the stock goes down by a corresponding amount anyway. So without growth, are the dividend payers really that great?

Hannibalis 25 Apr 2012 , 5:46pm

Hi ANuvver - I'm not sure I've ever advocated going for such low returns!

On dividends, of course they are great when they work but the experience of the past 5 years is that sometimes they don't.

As recently as 2011, 15% of FTSE dividend-paying companies failed to deliver
http://www.the-diy-income-investor.com/2012/04/how-reliable-are-dividends-uk.html

My own take is to split my portfolio between high-yield shares and high-yield fixed income securities, like corporate bonds, prefs and pibs. Better returns than the shares and much less volatile, Not risk-free, of course (that would be 4%+ for Consols)!

ANuvver 25 Apr 2012 , 9:09pm

So you're not a fan of sovs, I note!

Longtermyieldman 25 Apr 2012 , 9:10pm

Dividend paying shares are in my view the best stocks to own, in every circumstance bar one: a situation in which they fail, for whatever reason, to pay a dividend. If that happens, funds that focus on income are forced to sell them, and in addition to sacrificing cash flow, shareholders also suffer a loss in value.

There are two situations in which dividends are suspended. The first is when a company hits trouble; the second is when the economy as a whole comes a cropper. The first risk can be reduced by careful stock selection - ensure that divis are comfortably covered by cash flows, and not just earnings, and that debt is manageable. The second is harder to predict: will the Eurozone go pop?

duffmanchon 25 Apr 2012 , 9:42pm

Everyone talking about equity income, nope just people that invest. The great unwashed still have most of their cash invested in overpriced housing. I haven't heard anyone in the supermarket mention their stock portfolio!

ArkWelder 26 Apr 2012 , 12:14am

I subscribe to the theory that whenever a sector or asset class is being promoted to retail investors and they (or rather, 'we') are discussing it with Grail-like reverence, then the sector is close to a peak, and may even have passed.

Too many articles on too many web-sites over the past 12-18 months coalescing aroung the same viewpoint, i.e. 'equity income'. Seen this too many times over the last 25 years. Not trying to say that I think that (higher) dividend paying companies are heading for a fall, but that better opportunities might be lurking amongst more growth-driven strategies, especially on a 10-year view. Not that I will be selling out of dividend-paying assets completely, just that I'll continue to divert resources into (what I perceive to be) a more growth-driven approach.

Dialogue 26 Apr 2012 , 12:56pm

Bit concerned that (especially in the US) profits are historically high. We must be prepared for mean-reversion; with the state of the global economy at the moment, that means it's quite likely profits will start to disappoint next quarter, and that will take its toll on share prices.

If you agree with this, maybe take your divis and gains from the last year or so, convert to cash (get 3% before tax), and wait for some serious bargain-hunting. I know many of you will think this is unwise, and timing is always a concern, but do you seriously think the FTSE won't test 4800 again in the next 12 months?

Sell in May...?!

masudbutt 26 Apr 2012 , 1:02pm

I invested in Ishare stoxx select div 30 and Ishare FTSE UK DIV PLUS, many years ago, Reinvesing Div in both. Each showing nearly
40% capital loss.It hurt. I dont feel selling as I cannot take a loss, but I keep on reinvesing Dividends. hoping dividends will help to overcome the loss. I dont see any improvment for over long time, as I monitor these two Ishares. I can still afford to reinvest Dividends, but is it wise. Please let me know what can I do better, Thanks.

ScottishDavie 26 Apr 2012 , 1:16pm

I was only half-listening at the time but I'm sure I recently heard some MP-type person on the radio complaining about companies sitting on "mountains of cash" instead of using it to generate growth (how was not specified) and there seemed to be an implication that "something needs to be done" about this dastardly behaviour. As I say, I was only half listening and I sincerely hope I imagined it but that sort of statement should be of concern to any dividend investor. If politicians start interfering in what companies do with their own funds it will be seriously bad news for all of us.

Benatar 26 Apr 2012 , 4:34pm

Unless there are tax implications (i.e. a need to obtain gains as income or capital) I do not understand why everyone has to invest for income or growth. I Always invest for total returns. So when markets are stagnant I am more likely to look for a return via dividends. When markets are growing I will be more likely to look for returns via capital growth.

andrew97d 26 Apr 2012 , 8:24pm

If you had put £100,000 into the Aviva balanced managed fund in 1993, you definately will not have a fund worth £379,000 now. More like £125,000. The annual bonus rate on their with profit fund is currently 1.25%. My 24 year personal pension is maturing soon with a final value of £44,000 and the final bonus is a staggering £209.41 . Well done Aviva, how smug you must feel to have robbed the with profits fund to pay out compensation for mis-selling personal pensions. Any company that wastes so many million of naff TV adverts and sponsorship is clearly one to avoid. Buy your car insurance from them if you must, but ffs go elsewhere for investments.

dukindiva 27 Apr 2012 , 11:57am

Dylantherabbit

Balanced portfolio is short for not putting all your eggs in one basket !

So you should have a mixed set of asset classes that tend to balance each other out (in theory). Eg, When shares are falling, bonds normally rise and so does gold. Property ebbs and flows and inflation eats at the value of cash.
How much of what asset class (and there are others than those mentioned above) you have is down to your situation and attitude towards risk.

Thats a short answer to a complicated question... thats why financial advisors can be useful :-) (& no, I'm not one !!)

In my opinion dividend paying stocks should be a part of most peoples portfolio ... they probably are one way or another.

dukindiva 27 Apr 2012 , 12:15pm

Atolbot9

I tend to think dividends are a sort of bribe to buy some loyalty from their shareholders. Ideally you want growth & income... don't we all !!

No company has enough competitive advantage to maintain stunning growth forever, but some can grow for a long time & pay dividends (eg Apple, Coke, Gillette...) which is what you have to look for if divi's are your cup of tea.. the trick is to buy when you see a bargain.

goodlifer 27 Apr 2012 , 9:04pm

Hi Hannibalis,.

"Much less volatile."
Is volatility a minus factor?
If so why?

I rather like volatility

Possak 07 May 2012 , 12:48pm

mcturra2000, if the stock price doesn't recover in due course after a share goes ex-dividend, then that's a bad sign, yes, (and I was worried to see VOD do it) but the point is that it's not an actual loss.

atalbot9, isn't it received wisdom that dividend cover should be at least 2 times?

Ultimately, the point is that the dividend is paid out of the actual performance of the company. The share price is based on perception of the present or future performance. Relying on the latter is a lot closer to gambling than relying on the former.

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