I nearly went with something along the lines of ‘Actresses and Bishops’ because that tends to draw a big Readership also but I didn’t think I could stretch what seems to be the dull subject of Dividends that far. I also know that a small chunk of Readers are under 18 so I need to keep it clean (ish).
I have actually stolen the title from my mate Cappy (@SmallCappy on Twitter) who always comes up with this term when we mention the wonderful phenomenon of nature that is the humble Dividend Payment. He has nailed it with such a description and I am fully onboard with his use of this term and I shamelessly pinch it whenever I can (you should have copyrighted it when you had the chance, mate !!).
Impact of Dividends on Returns
There are many reasons why Stocks that pay a reasonable Dividend are attractive and I will cover more of them in due course but at a high level, the way I think about Dividends is that if I am aiming to make 10% a Year CAGR (Compound Annual Growth Rate) on my Portfolio in total then if I buy Stocks that pay out a Dividend Yield of around 3% it means that 30% of my Target for a given Year is taken care of without me having to lift a finger (or press any buttons !!) - that is a huge help towards my Goals.
This 10% CAGR applies to my ‘Normal Trading ISA’ (if you go to my ‘Portfolios’ page then you can get a full breakdown of my various Portfolios and the Stocks I hold within them) and of course when it comes to my ‘Income Portfolio’ the main focus there is on a Blended Dividend Yield of 5% across all the Stocks I hold and the Total CAGR Return I am looking for is 7% a Year.
Many Readers will be unimpressed by such Returns (this could be a mistake and if you really feel that way you might be deluding yourself with regard to what Returns are possible and sustainable and you might be taking on far too much Risk) but it has to be appreciated that my Income Portfolio is all about producing a Return that is higher than what I can get from Cash in the Bank and doing this in a way that has Lower Risk than my Normal Trading ISA and it is achieved with very little effort in terms of Trading Activity with Buys and Sells being infrequent and mainly focused on Buying more of what I have already and Re-Investing the Dividend Payments. You can also see more about my Portfolios if you look under the ‘Blog Category’ ‘Scores on the Doors’ where each Year in early January I write a full and detailed breakdown of what my Portfolios have achieved………..and a full and frank discussion of where I have screwed up and need to focus my efforts to improve !!
Its very obvious that if I am looking for 7% Return each Year from my Income Portfolio, then with the Dividend Payments (which also are likely to grow each Year by the way) already delivering 5% in ‘Free Money’ it means I need a mere 2% from Capital Growth to hit my Target - not too difficult as the reality of my Returns clearly shows. While I’m talking about this I must just mention how running this Income Portfolio for the last 4 Years or so has really made me appreciate the value of Dividends even more and it has also taught me an important lesson about Inactivity. By concentrating on limiting my Buys to only Stocks of a very high and reliable Quality I can sit back and relax while my Stocks and their Dividends do the hard work for me. It is obvious that in many years when I get even older and perhaps are less able to focus on the ‘work’ involved in Trading Stocks I will move more of my Approach to this Low Risk, Low Effort, Decent Returns philosophy.
Simply put, to me, Life is far more important and valid than wasting it by sitting in front of a Screen all day. Not for me that. By the way, I'll be in the PUB all day tomorrow !!
I have included an extremely important Blog I wrote millions of years ago (actually I am lying, I did not write it, I just gave a Tyrannosaurus a Biro and he scribbled it down for me. It is such an established and Natural Mathematical Phenomenon of the Ancient Prehistoric World although the Saurus did struggle with holding the pen) at the end of this Blog and it addresses the critical Subject of Compounding and how this is the real key to making Returns over time and how it is particularly important for Young Readers to get their Heads quickly around this concept because they can benefit hugely from all the Years of Compounding they have ahead of them. OK, when you are Young you have the drawback of having Less Capital but if you learn quickly and avoid all the stupid Mistakes like buying AIM Garbage then you have Compounding fully on your Side and with your Money doubling every 7 Years if you can grow it at 10% CAGR then it is obvious how once you get in your Forties and Fifties you will be very loaded - and this is especially the case if you can tuck aside a few Quid each Month to help grow the Pot.
There is also this thing called the ‘Rule of 72’ (there is a Blog at the end also) and you can read up on it but for example if you can get your Returns up to 12% a Year then your Money will double every 6 Years and at 15% (this is a very hard target to achieve though) your Money will double every 5 Years.
So I guess if we boil it all down what I am really saying is that One Pound today is actually worth a huge amount more than that when you Compound it at 12% or whatever into the Future. So when you Receive or Save a Pound today that in reality could be worth a Future Value to you of perhaps as much as Five Pounds or more - and this is the beauty of Dividends - you receive them Today at a particular Value but in Future Compounded Terms they are worth a huge amount more. For example, let’s say you hold a Stock and you get a Dividend Payment off it of £64 - you might think “Big Deal, it is just 64 Quid - a couple of Meals in a Pub” but when you project forwards and Compound that £64, it might be worth perhaps £1000 to a future version of yourself who is Middle Aged or whatever (and before you Young ‘Uns start thinking that is ages away, believe me that the time will disappear in the blink of an eye !!). That is the Power of Re-investing Dividends and Compounding the little devils.
It’s even more wicked when you consider that initial £64 was really ‘Free Money’……
Covering your Costs
I know Robbie Burns, The Naked Trader, says in his superb Books about how the Dividends he receives cover his Dealing Costs - and this can be a useful way to consider your Dividends and the advantage of receiving them. However, I prefer to frame Dividends in the way I have discussed above that if I am after 10% CAGR Total Return on my Portfolio, then receiving 3% in Free Money is a nice big step on the way to achieving my Return Targets.
There is a simple reason for why I prefer to ‘frame’ it in this way - the simple fact is that even if you don’t receive Dividends because you tend to Buy and Sell Stocks that do not pay a Dividend, then you still have these huge Dealing Costs and you have no way of covering them. You need to make Capital Gains (and that is, after all, the hardest bit of what we do) just to get back to Breakeven after Buying any Stock and if you Trade a lot then your Total Dealing Costs could be a huge drag on the Overall Performance of your Portfolio (I suspect many ‘Investors’ / Traders totally overlook this drag).
As the Years go by I find that I do less and less Trades and I am of a Mindset these Days that I want to hold Very High Quality Stocks in a Diverse Portfolio and I want to hold onto those Stocks through Thick and Thin (ok, I could do without too much of the ‘Thin’ !!) and this also has the benefit of meaning my Dealing Costs are very Low. I have not bothered to work it out, but I suspect that my Total Dealing Costs are 1% or so on my ‘Normal’ Trading ISA - and therefore if I get a Dividend Yield of 3% over the Portfolio then I am 2% to the good already.
Robbie says that he worked it out Years ago and that his Dividends almost exactly covered his Dealing Fees - and he Trades a huge amount. On that basis, my Fees must be relatively tiny. Of course as your Portfolio grows in Monetary Value, there are ‘Economies of Scale’ when it comes to Dealing Costs but I guess once you get a few Hundred Thousand Pounds worth of Stocks it becomes less beneficial as your Pot grows (‘Diminishing Marginal Returns’ and all that).
On my Income Portfolio I almost never do any Trades - for example for 2018 so far I suspect my Dealing Fees don’t even amount to £100 (and that includes the ‘Spread’ as well). £100 of Fees would be just under 0.2% of the Portfolio Value (remember my Target Return from Dividends is 5% so this level of Costs barely even registers). Obviously when you are first starting out and building a Portfolio of Stocks from scratch, your Dealing Fees will be unusually high but over time they reduce significantly.
Sign of Quality
There is a theory put forward by many Investors that it is best for a Great Company that is growing and has loads of Opportunities to keep the Cash it generates from Operations and to re-invest that in the Business and fuelling Growth. In fact, that is very much the Model of Companies like Amazon ($AMZN) in the Tech Sector who never pay a Dividend and of course Investors in the Shares have done extremely well from the Capital Growth. But in general terms I suspect that the kind of Company that can grow like Amazon for so many Years at such strong Growth Rates is extremely rare and most Companies simply cannot re-invest the Spare Cash they create (and no doubt at some point in the future $AMZN will also face this ‘Diminishing Returns’ problem).
Once Companies get to a certain level of competence and have established themselves in their Marketplace, it tends to be that they start paying a Small Dividend and what I really like seeing is commitment by the Management to a ‘Progressive Dividend Policy’ which essentially means that the Company commits to paying a Dividend with the intention of increasing it by a bit Year on Year. When you can find Stocks that have this kind of commitment and who have demonstrated Year after Year that they can deliver on such a promise, these make superb Investments because as the Dividend rises it tends to drive up the Share Price with it - so you win in 2 ways - you get a sweet and Rising Dividend and you get Capital Appreciation as well.
That leads me onto something else I had scribbled down on my very slapdash ‘Blog Plan’ - the idea that the Value of any Company today is merely the Sum of its future Dividend Payments discounted back to a ‘Net Present Value’ today by the use of a Discount Factor (this is the essence of working out a Valuation using ‘Discounted Cashflow Analysis). Some people use this extremely complex (and dubiously unreliable I find !!) method to Value Stocks but I never use it. However, it is an important concept to understand how a Stock should be Valued and it certainly should get over the point that the Dividends a Stocks pays back to its Owners is what really matters.
A Growth Stock that doesn’t pay any Dividend is merely being Valued as something that has huge Potential to pay Dividends in the Future, and bear in mind that if the Company never pays a Dividend then its True Value is Zero - keep this in mind next time you buy a piece of ‘WheelieBin’ AIM trash !! (look at the ‘WheelieBin’ Page on this Website if you don’t understand what I am getting at by that designation).
Having to pay a Dividend puts a positive and forceful discipline upon Directors to ensure that a Company is well run Financially and that they keep on top of the detail. When you have a Strong Growth Business in a Fast Growth Sector that is fairly new, it is often the case that there is no discipline within the Business and you find that they waste money in high Salaries and Options Schemes and Free Fruit Bowls for the Employees and Corporate ‘Away Days’ and other nonsense - I always think back to the Dotcom Days around 1999/2000 when this sort of Corporate squandering of Shareholder’s Money was utterly rife.
So, what I am trying to say is that when you have a Stock that commits to paying a Progressive Dividend that is a good discipline upon the Management and it means that Shareholders are getting a nice little ‘Thank you’ from the Company for sticking with the Shares and going along on the ride over time. So the existence of a Dividend with a record of Growth is a good sign of Quality when buying into Stocks - and on the flipside, beware of Stocks where the Dividend is being cut and/or the Dividend is likely to be cut because Growth is faltering and there is likely to be trouble ahead.
Technical Price Support
I often use the concept of ‘Dividend Support’ when looking at a Share Price Chart - particularly in one where there has been some sort of Trading Problem or perhaps it has just got into a Downtrend for no particular reason (this happened to ESUR recently as I pointed out in a Weekend Charts Blog and once it broke the Downtrend it has risen in a very pleasant manner). What tends to happen is that something that pays a fairly juicy Dividend, let’s say 6% as an example, only falls to a certain Level before the Dividend Yield gets so High that Income Buyers are naturally drawn in to the Stock. This helps build a Floor under the Share Price and can often stop it falling further. This sort of thing is particularly noticeable on Large Stocks that pay generous Dividends and I often find that these trade in a Range over many Years which tends to have the Lower End of the Range determined by the Dividend Yield when it falls down to that Price. Stocks like Sainsburys SBRY and GlaxoSmithkline GSK move in such Ranges.
Spreadbets in the Long Term
There’s a common misunderstanding that Spreadbets are for Short Term Trading - this is very silly because it means that 95% of People are missing out on a great way to Boost Returns by holding Stocks Long Term as Spreadbets (and there is also a useful side-effect that you can hold Foreign Currency Stocks with no Forex impact because you can bet ‘Pounds per Point’ on their Price even though it might for example be in Dollar Cents).
If you hold a Long Spreadbet for a Year, then you get hit with an Interest Charge which is in the region of 3% to 4% for the Year (with igIndex this is calculated as something like LIBOR plus 2% and it is therefore variable) but the important thing to realise is that if you are receiving Dividends on those Long Positions that are equivalent to about 3% across the Portfolio, then your Finance Charges are pretty much being covered.
Having said all that, at some point we might find that Interest Rates rise a lot and this way of using Spreadbets will no longer work as the Financing Charges will become too high - it is something to be aware of but I suspect that is many years away as yet.
This is exactly what I do with my Spreadbet Account and I in effect ‘Mirror’ my Normal Shares which are in my ISAs with Long Spreadbets which means that I am using Gearing (Leverage) so that for a relatively small amount of Capital I can get Exposure to the equivalent of a much higher Value of Normal Shares. I will put a Link at the bottom of this Blog to a Series I did on how I use Spreadbets which if you read carefully should explain this to you properly. But be careful because Spreadbets and Leverage of any sort can be extremely dangerous if you do not understand what you are doing and keep fully in control at all times.
I put a Heading in marked ‘Conclusion’ so I suppose I ought to write something in this space. Not sure what to say though - it is all there above really. I guess I can point out that ‘Free Money’ is always worth exposing yourself to (but I do not recommend ‘exposing yourself’ in other ways - especially if there is an Internet Connection and a WebCam involved).
So don’t overlook Dividends and keep buying that AIM WheelieBin Garbage that your psyche so attracts you to - get some Quality Dividend Payers and start banking the easy Cash.
And have a much more peaceful and profitable life.
Here is that extremely important one on the Power of Compounding - I am sure that if I could only have one Blog on this Website, then that would have to be the one:
This one goes on about the ‘Rule of 72’:
These Blogs are dedicated to how I run my Income Portfolio (this Final Part has links at the top to the earlier Parts):
And finally here are those Spreadbetting Blogs I was on about (if you scroll to the bottom there are Links to the earlier bits):