The value of dividends
Written May, 2023
Readers of my books will know that I’m a fan of dividends. For my core investments, I’ve always liked investing in companies that pay good dividends – preferably franked. My reasoning is based on the following:
1 Shareholders deserve dividends
2 Dividends are a good indication of profitability
3 Dividends provide steady income for investors which is often tax-free
4 Dividends hedge against inflation
5 Dividends hedge against capital loss
6 Reinvested dividends are a great way to grow long term wealth
Let’s look at these more closely
1 Shareholders deserve dividends
Company directors don’t actually own the business or any part of it unless they own shares in the business. Directors have no obligation to own shares in the business and indeed in some countries directors aren’t allowed to do so. Regardless as to their shareholding (or lack of it) it’s commonplace for directors to pay themselves healthy (and sometimes very healthy) bonuses based on the profitability of the business. On the other hand shareholders actually own the business and are the ones taking all the risk. Therefore I believe the shareholders and not just the company executives are entitled to a slice of the action, which dividends provide.
2 Dividends are a good indication of profitability
It’s well known that clever accountants and directors can (and usually do) present the figures to make them appear in the best possible light. There’s nothing dishonest about this but it’s just a way of presenting information so as not to deter investors. If the profits aren’t growing or if the company is running at a loss, you can be sure the directors won’t highlight this. Instead they will point out all the good things about the business – such as: a great product, green footprint, improving health and safety, the things being done to grow the business – and so on. But dividends can’t be massaged – the company either pays a good dividend or it doesn’t. Regardless of anything else, a steady or growing dividend is a very good indication of company profitability. After all, if the business isn’t making good profits it can’t afford to payout a dividend.
3 Dividends provide steady income for investors which is often tax-free
Just like a bank account, dividends provide an ongoing income stream for investors. Usually dividends are paid every 6 months but some managed funds and ETF’s pay the dividend every 3 months. And if the dividend is fully-franked or has a high level of franking all (or most) of the dividend can be essentially tax-free. Compare this to bonds or interest bearing accounts where all the income is usually fully-taxable.
4 Dividends hedge against inflation
Inflation goes on relentlessly and means that idle capital is losing value each day. So if the share price doesn’t change over a period of time, your shareholding as still losing value. Dividends can offset this, and ensure your real wealth isn’t decreasing. For example if you can get a 5% ff dividend your real wealth isn’t decreasing even if inflation is running at 7%.
5 Dividends hedge against capital loss
Although all share holders would like to see the value of their shares steadily rising, it’s a fact of life that share markets go up and also down. And in times of downturn, a good dividend provides a hedge to help offset capital losses because the dividend is usually not affected to the same extent as the share price downturn. Not only that, but history shows that when severe market downturns occur, dividend-paying stocks outperform others. So on both counts dividends provide a hedge for investors.
6 Reinvested dividends are a great way to grow long term wealth
I recently delivered a presentation for the Australian Investors Association. As part of this, I made a spread sheet with figures and graphs comparing three scenarios:
- Dividends taken out and used as income
- Dividends re-invested (using the drp if available).
- Dividends and franking credits re-invested.
I assumed an average 5% capital growth and a 5% ff dividend. The percentage increase in value of the shareholding was as follows:
| Years | Scenario 1 | Scenario 2 | Scenario 3 |
| 5 | 21.6 | 55.1 | 78.1 |
| 10 | 62.9 | 253 | 310 |
| 20 | 265 | 671 | 893 |
The figures speak for themselves but you can see that even in the comparatively short time period of 5 years, reinvesting your dividends is a great way of growing your wealth.
Conclusion
As long as I have been a share investor, I have heard the arguments for and against dividends. Some believe that capital growth is far more important than dividends and cite the US market where most dividend-paying shares pay a much lower dividend than is the case with our market. However, I’ve always believed that a good dividend is important for core shares and I believe the benefits I’ve outlined above prove my case.