It's all about company earnings 14/10/20
It’s all about company earnings
In recent weeks we have received some great feedback in regard to my recent article titled The Key to Investing.
In this article I compared a popular bank share, that paid a high dividend, against a growth company in the Health Care sector that my clients have been invested in since 1999.
Several readers wanted to know why I place so much emphasis on the link between earning and share growth, while another felt that I was being unfair on the banks as “they always pay good dividends, and that’s what I need to live off”.
In the article I compared a $100,000 investment in June 2005 into the bank and the growth company. Both companies grew their earnings by 10-15% over the next decade so their share prices increased to $175,525 and $175,612 respectively over the next 10 years. Not much difference, and a clear link to earnings growth.
Since 2015 the bank’s earnings growth fell to 1% per annum by 2019, while the growth company has continued to grow their earnings by 10-20% per annum.
Today a $100,000 investment in the bank is worth $91,910 while the growth company shares are now worth $467,302. It is quite a difference, and clearly demonstrates the link between company earnings and share price.
But what about the good dividends from the bank shares?
Well, the bank shares mentioned above were paying a dividend of $2,300 in 2005 on a $100,000 investment, but now the dividend is only $827 on the $91,910 market value, while the dividend from the growth company has increased from $2,100 in 2005 to $8,286 in 2020. So the key to increasing dividends is also earnings growth.
This is why analysts monitor company earning so closely. Companies each year provide in their Annual Reports forward earnings guidance. During the following year if there are material change to forward earnings guidance they have a legal obligation to inform the market.
If a company misses their earnings forecast their share price is usually savaged. If a company does better than forecasted then their share price usually increases. Thus, it’s all about solid earnings growth and achieving future earnings targets.
Another reader has asked whether any of the banks are still worth retaining. In the table below I have provided earnings growth estimates and dividend estimates over the next 2-3 years for the banks and another popular high dividend paying company.
As you can clearly see the outlook over the medium term for two of the major banks is very poor, as is the telecommunication company that many retirees invest into for their ‘good dividend’.
In fact an investment spread across these five companies is likely to return a negative 0.5% per annum in coming years. This assumes that the market holds up and that they achieve their earnings guidance.
I feel that there are six standout companies in Australia at the moment. These companies should all continue to grow their earnings by between 9% and 30% per annum over the next three years.
Including their dividends, that range between 0.9% and 3.8%, we estimate that our clients will return an average of 14.1% per annum over the next two to three years from the combination of these companies.
Next week I’ll talk more about these companies and discuss my doubts that diversification will work over the next decade.
In the meantime, if you are interested in having your investment portfolio reviewed to ensure that you are not exposed to the wrong investments, please give me a call (91600288) or email my office at firstname.lastname@example.org
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Lanham Financial Advice