Here at the Motley Fool, we've long been highlighting the virtues of quality dividend paying stocks, especially in the current low interest rate environment. Understandably, though, some investors get a little nervous when it comes to the share market.
It wasn't that long ago that the ASX essentially halved from the 2007 high to the 2009 low — and while it has since recovered, those that are dependent on an ongoing income may have been forced sellers at the worst possible time.
Some investors will also point out that while dividend yields are better than what you are likely to get in a bank, the difference isn't massive, especially when you consider that there is virtually zero chance of a loss when you invest in a term deposit.
Take for example Commonwealth Bank (ASX:CBA), which is presently offering its shareholders a yield of about 4.6%. Not bad, sure, but It isn't exactly miles above the 3.5% you can get — risk free — by instead investing in one of CBA's term deposits.
In fact, as you'll see in the chart below, even over the long term, CBA's dividend yield has never been far away from 'risk free' interest rates:
Kinda takes the shine of dividends, right? Well, let's not be so hasty.
To truly appreciate the attractiveness of dividends, we must remember that yield is calculated by dividing the dividend by the share price.
And the reason CBA's yield has failed to show any material appreciation over the years is that its share price has the remarkable tendency to keep growing!
So although dividends have done this:
The share price has, at the same time, done this:
Little wonder the dividend yield doesn't appear to have changed much!
Rather than looking at the dividend yield each year, it's better to look at what our income returns would have been like if we invested $10,000 into CBA shares and a term deposit, back in 1992 (when CBA first listed on the ASX). For now, we'll ignore the change in share price, and only consider income.
Although term deposits provided a better income return for the first two years, the growing dividend payout from CBA soon saw it eclipse the interest income from term deposits. Over time, the growth in dividends has blown the interest income clear out of the water!
You may also notice that CBA shareholders received a pay cut only once over this entire period — during the GFC. Even then, the drop was a modest 14%, and it was back at record levels the very next year.
Of course, things look better for the cash focused investor when the interest income is reinvested. The power of compounding acts to multiply returns — significantly:
By reinvesting interest income, the risk averse investor has generated a healthy 232% gain over the period. Not bad.
That is, not bad until you compare it with the gains that came from reinvesting dividends in CBA over the same period:
That's a 4,000% return compared with a 232% return in cash. Chalk and cheese. In fact, so powerful have the effects of dividends been, the 1,000% capital gain on the share price actually looks disappointing on this chart!
Yes, there is some short term volatility with share prices, but when you are invested in a quality company, there is virtually no volatility with dividends. Just look again at the income return from CBA.
If you want to talk about risk, consider the risk of having your money eroded by inflation.
The risk of missing out on far superior investments that offer BOTH income AND growth — like quality ASX dividend-paying companies.
And, the risk that interest rates are likely to stay lower, for longer.
For the long term investor, there is far less risk investing in quality companies. And there are lots of great companies like CBA out there that are offering regular, reliable and rising dividends.
Dividends that despite any economic bumps, despite the ups and downs of the share market, will continue to drop like honey into the bank accounts of happy shareholders.
Think beyond this year's yield. Think Big. Invest in dividend-paying companies now.
Trading on a forecast fully franked dividend yield of around 4.3%, or a juicy 6.2% when grossed up for franking credits, my new recommendation for members of Motley Fool Dividend Investor is a case in point. I already own shares in the company. Following my recommendation, Motley Fool General Manager Bruce Jackson also bought shares in this well-known yet "under the radar" ASX mid-cap stock.
If it's good enough for us…
