You probably know that dividends from quality companies are a wonderful source of income. An income that tends to grow well above the rate of inflation, that is independent of the sharemarket's mood, and one that is extremely tax effective.
But did you know that a focus on dividend paying companies helps you significantly boost your chances of beating the market?
Just Beat It
If you're going to invest directly in the sharemarket, you want to make sure you can beat the performance of the average — as measured by one of the leading indices, such as the All Ordinaries index. Why?
Well, you could save yourself a whole bunch of transaction costs and risk — not to mention your precious time — by just investing in a low cost index fund. Such an approach is likely to offer you a very respectable return, and chances are you'll end up beating most professionally managed funds!
So there is no point in taking on all the effort, cost and hassle of direct investing unless you think you can do better.
But what are your chances?
Tread Carefully
A look back over the past five years shows just how much the odds are stacked against you.
Of all the companies listed on the ASX today, about 1300 of them have been around since early 2010. And since then, the All Ordinaries has notched up a total gain of about 48%, when dividends are also factored in.
Here's the scary part — three quarters of all of these companies did worse than the benchmark index.
In fact, about 60% of all listed companies actually lost money for shareholders over that period, some meaningfully so.
Don't Go There
So which company topped the charts over the past five years? It was Northern Star Resources (ASX:NST), a gold miner whose shares have gone from 3c to about $2.40 today!
$1,000 invested in Northern Star 5 years ago is worth more than $74,000 today!
But don't think that that's the typical result for those that invest in mining companies — far from it!
Of all the companies that have underperformed the market since 2010, two-thirds belonged to the mining and energy sectors. Worse, about 40% of companies in these sectors actually lost more than 90% of their value! Even if you had invested in every single one of these companies — including the superstars like Northern Star — your average return would have been -49%.
If you are trying to beat the market, these are very dangerous waters to fish in…
Boosting Your Odds
As I've said before, the best indicator of company health is an ability to pay a dividend — it's difficult to fake cold hard cash!
And if you only focused on dividend paying companies over the past 5 years, your odds of outperformance improved dramatically.
Since 2010, your chances of beating the market more than doubled if you only looked at income producing stocks. Further, your chances of losing money approximately halved.
And it's not like you had to accept mediocre returns — over a third of dividend paying companies achieved a total return that was more than double the market average. And, if all you ever did was buy every dividend paying share on the market 5 years ago, you would have achieved an average total return of 79%, compared with the market's 48.5% total return.
Stick To The Winning Formula
There are many reasons as to why we focus exclusively on quality dividend paying stocks at the service I run, Motley Fool Dividend Investor.
Sure, we like reliable, rising and tax effective cash payments. Especially when bank deposits are so woefully low!
But we also like good growth in our shares too, and we want to beat the market without taking unnecessary risk. And as you can see, focusing on dividend companies goes a long way to ensure the odds are in our favour.
It's perhaps not surprising that the Motley Fool Dividend Investor scorecard is well and truly beating the market since we started the service last year — in fact, our recommendations have collectively provided a return that has been well over double the market average in that time.
Taking A Broader View
Of course, these historically low interest rates have also driven many others to seek out the best dividend payers, and that's a big part of why the market has done so well of late. But all that money has pushed many of the big names to prices that no longer represent great value — and ironically, the price rise has meant the dividend yields aren't quite what they once were…
Unlike most fund managers or brokers, here at Motley Fool Dividend Investor we aren't restricted to just the top 200 companies — we are able to cast a much wider net. In doing so, we've uncovered some wonderful companies that are offering truly impressive yields and growth potential. And, of course, companies that are very low risk and capable of sustaining dividends across all stages of the economic cycle.
Just consider my latest recommendation — whose name I won't reveal out of respect to our members. But what I can tell you is that it is offering a grossed up yield of over 5%, and has managed to increase its dividend by an average of 18% per year since 2006. During its recent half year results, it reported yet another strong lift in profit and rewarded shareholders with a more than 12% increase to the interim dividend.
Best of all, it still represents outstanding value today.
Foolish Takeaway
Forget trying to chase speculative mining companies. A focus on quality dividend paying shares will ensure you have every chance of achieving a solid market beating return, a big part of which will arrive in your bank account every 6 months in the form of cold, hard cash.
