Focusing on reliable income streams makes particular sense given uncertainty over how long this share market recovery might last. Bank deposit rates will be far less attractive for many investors following the series of official interest rate cuts since last September. It may be preferable to choose stocks that have an equal or better yield and provide tax effective income with the opportunity for capital gain in the years ahead. The aim is to choose companies that produce dividends we can rely on – companies that can be held for a long, long time.
Why focus on dividends
Dividends are a key component of total shareholder returns, the other being capital gains. We can’t expect the market to return more than the usual 8–10% over the next few years, so if we purchase reliable stocks yielding 5% we are already half way there. Conceptually, the value of a company is the sum of all future dividend payments so it pays to seek companies with reliable and preferably growing dividend streams.
Less than a third of ASX-listed companies pay dividends and not many of these maintain or even grow them year after year. The best companies do. But some companies struggle in difficult industries, with high debt levels, poor business models or poor management and have to cut the dividend as many have done recently.
When we invest in strong businesses that pay reliable dividends, daily share price movements don’t need to concern us so much. Instead, we can look forward to banking those dividend cheques as they come on a regular basis.
Some consider robust dividend providers as stodgy investments, but they can provide impressive capital growth also. A rock-solid dividend stream is often an indication of a solid business with strong cash generating ability. This is probably through generous margins and limited requirement to spend a lot of money to grow the business. These healthy fundamentals can lead to a growing earnings stream, adding more value to the business and helping support a rising share price over time. Higher quality stocks will hold up better than most through downturns and can produce more reliable returns.
