By STEPHEN MARRIOTT 30/09/2010
There has been a lot of talk recently about the importance that dividends make to overall equity returns. Such talk isn’t surprising given that the current yield on equity markets looks much more appealing than bond yields. For example, the FTSE 100 is currently yielding 3.3% compared to 10 year government gilts yielding around 3%.
Compounding matters
Currently stocks yield more and offer some potential for growth, but are more volatile. However, it’s the compounding affect of reinvesting dividends that really enhances stockmarket returns. In the period from 1986 to September 2010 the capital return (without dividends reinvested) of the FTSE All Share was 295%, whereas total returns, i.e. with dividends reinvested, amounted to 889%. For example, Neil Woodford, during his tenure managing the Invesco Perpetual Income fund outperformed the FTSE All Share by 110%. In 19 years the cumulative dividends generated by investing £10,000 in Invesco Perpetual Income amounts to £25,420 and the total return would have been £88,212.
So if the bulk of equity returns come from dividends it probably makes sense to spend more time analysing dividend payouts than profits. Fund managers that run Equity Income funds typically have a goal to raise the level of income yielded by their fund. Therefore these managers spend more time forecasting payouts.
Diversifying income
With BP hitting the headlines in the summer, dividend seekers were reminded that a dividend is never guaranteed and also the fact that UK dividends are concentrated - the top ten UK dividend payers account for more than 60% of total dividends paid out. Equity income managers are attracted to higher dividend companies, but this is not their sole criteria and what they’re really looking for is those companies that can grow their dividends. Therefore, they won’t necessarily be buying the highest dividend payers. However, a number of our Equity Income managers have recently suggested that finding good income payers is not a problem and generally they expect their portfolio yields to increase. As such, the loss of BP’s dividend has not caused too many problems. Interestingly Neil Woodford actually sold BP before it cut its dividend back in October 2009.
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