Most Australian investors focus on attaining as high an income yield as possible in the hope that it matches their living expenses. Often share investments are selected based on the level of dividends that a company is paying.
However, as we have seen through each investment cycle this ‘chase for yield’ has always ended badly, and is likely to be no different through the current cycle. In fact , investing into Australia’s most popular ‘high dividend paying’ companies over the last five years has seen investors lose capital.
As an example, $100,000 invested into shares in one of the four major banks in 2005 would now be worth just $91,910 today. Over this 15-year period dividends of $118,689 would have been received by an investor, so the net gain would be $110,599.
This may appear to be a reasonable result, but as the capital value has diminished, so too has the dollar value of the dividend paid, which contradicts the purpose of the ‘high dividend’ approach.
An alternative approach is selecting companies that are focused on growing their business rather than paying out most of their earnings as dividends to shareholders.
Growth companies usually pay low dividends of between 1% and 2% in recent decades as their focus has been on retaining more than 50% of their profits to grow the business through acquisitions or investing in research and development.
With the rising share price, the dividend from this growth company has also grown in dollar terms. Over the last 12 months dividends paid to shareholders has been $8,286 which is superior to the dividend that has been paid to the bank’s shareholders of $4,096.
Over the 15-year period the total dividends received by the growth company’s shareholder would have been $80,411. Thus, the total gain on the $100,000 investment in the growth company 15 years ago would be $447,713 which is quite superior to the $110,599 made on the same amount invested into the high dividend paying bank share.
It is easy knowing in hindsight what companies we should have invested in over past years, but of course past performance is no guarantee of future performance. The key to investing, we feel, is knowing which companies will continue to grow over coming years.
The method that we utilise to determine the most appropriate companies to invest in is based on earnings growth. We feel that there is a clear link between earnings growth/decline and share price increases/decreases.
This is why analysts and researchers place so much emphasis on monitoring company earnings growth. Companies each year provide in their Annual Reports forward earnings guidance. During the following year if there are material changes 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 forecast then their share price usually increases. Thus, it is all about increasing revenue to achieve future earnings targets.
Our analysis of the major bank and the growth company’s shares over the last 15 years clearly illustrates the link between growth/decline and share price increases/decreases. From June 2005 to June 2015 both companies grew their earnings by 10-15% per annum and their share prices increased to $175,525 and $182,612 respectively over this period.
Since 2015 the major banks’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. Along with the major bank’s declining earnings growth, their share price has also fallen over the last five years.
It is quite a difference, and clearly demonstrates the link between company earnings and share price, while our analysis of their dividends also demonstrated that they are also linked to earnings growth.
With the rise or fall in share prices of companies following their earnings growth or decline, it is possible to project returns out with some degree of certainty by adding their forward earnings forecast to the expected dividend to be paid.
It will not of course match exactly, as there will be ups and downs in the market along the way, but it is a useful approach to compare different companies and make a prudent choice of what combination of companies will achieve the desired return.
Investing in just eight companies may not appear to be adequately diversified, particularly as most retirees and advisers are often positioned to invest in most of the top 200 Australian companies.
However, given the health and economic challenges that the world faces over the next decade, we feel that almost certainly these challenges will make obsolete diversifying across so many companies through a managed fund or ETF.
We feel our clients will need to be invested in only the standout Australian companies to protect their wealth against negative earnings growth, falling share prices, and achieve the returns that they will need to maintain their lifestyle.
We have been using Peter’s expertise in all things financial since 1990 and have always been impressed by his diligence, honesty and integrity. Our financial goals are on track under his care and we are always confident that he has our best interests at heart when making recommendations and investment decisions. We can highly recommend Peter and his dedicated team’
We have been clients of Peter for many years now. He has always given sound information in his newsletter on the performance of our investments and made appropriate suggestions as to and when they should be changed to ensure that they are performing to our needs.
I am a retired company accountant and have been comfortably living off reasonable interest and dividends until recently. A friend recommended Peter so we sought his advice to deal with the current and probably long term dilemma of low interest rates. Peter has provided my family with invaluable advice for the management of my investments both inside and outside Super.