A dividend focus pays off

Although dividends don’t make headlines compared to the latest company earnings reports, they are exceptionally important when valuing a share and when investing.

 Total Return of company = (Dividend÷Share price) + Dividend growth 

This equation, from The Theory of Investment Value by John Burr Williams, the father of dividend investing, shows just how significant dividends are in deriving a company’s total return. One of Williams’ key insights was to ignore the market “buzz” – such as that created by short-term earnings reports – and focus on both a company’s actual dividend payments and dividend paying potential.

To understand the dividend-generating capacity of a company, you must look at three main indicators: its current dividends, its earnings and its book value. Ideally, for us to consider including a share in the Prudential Dividend Maximiser Fund, a company should score highly in its growth of all three of these, and the company’s share price should also look cheap relative to all three.

Steinhoff is an excellent example of a group that had good earnings but persistently negative cash flow. It was paying dividends, but these were financed largely through borrowing and share issuance. So these were essentially “trick” dividends, paid to trick investors into thinking the company had cash flow.

Beware of focusing only on dividend yield
Dividend yield (dividend per share÷share price) shouldn’t be the sole measure to use when building a dividend-focused portfolio – sustainability is equally important. A company’s share price may be cheap for a reason, giving it a high dividend yield. For example, when Anglo American stopped its dividend during 2016, its share price had already been underperforming the broader JSE. Passive ETF-type funds tracking high dividend-yield shares had consequently been increasing their exposure to the share, blindly following its rising dividend yield, and even bought more shares just before the dividend was cut to zero. When Anglo American actually stopped its dividend, passive funds were forced to sell all their shares. Then when the company resumed its dividend payment 12 months later at a much higher share price, these funds had never bought back the share and so completely missed out on the strong rally in its share price - and the attractive dividend. However, some active managers like Prudential were able to capitalise by cutting exposure to Anglo American early and buying it back again while the share price was still cheap, subsequently benefitting investors with both share price outperformance and attractive reinstated dividends.

Proof that dividends do matter
The performance of the Prudential Dividend Maximiser Fund (shown in the graph) demonstrates how investors benefit from an investment approach that focuses on companies offering both a sustainable dividend yield and long-term growth in dividends. Over the 15 years to 31 August 2018, the fund ranks #3 out of the 35 funds in the ASISA General Equity category, and has returned 18.4% p.a. after fees, strongly outperforming the category average of 14.7% p.a. over the same period. The graph also highlights how the Dividend Maximiser Fund has beaten by 2.0% p.a. the FTSE/JSE All Share Index return over the same period. So when the headlines scream “Earnings skyrocket!” be sure to consider another critical dimension by asking yourself: “But what about the dividends?”

To benefit from the power of dividends, speak to your Financial Adviser about investing in the Dividend Maximiser Fund or complete an online application form.