The Motley Fool

Growth and income: The best of both investing worlds

Australia has long been a dividend-lover’s market.

With our concentration of financial stocks (banks, insurance companies and the like), our dividend-friendly taxation system and a relative dearth of high-growth businesses such as technology and pharmaceutical companies, it’s not surprising that our market sports an above-average dividend yield.

Even after the recent rally, with share prices still largely down across the board (in some cases significantly), many quality Australian businesses seem oversold relative to their fundamental earning potential. That simple reality makes this a buyer’s market.

Fight the fights you can win
Has the market hit the bottom? I have absolutely no idea. At all. I could spend days trying to get to grips with that question, but ultimately I would still have no idea. Thankfully, success doesn’t require me to.

I don’t need to know if the market has hit the bottom. All I need to know is whether the companies I hold and buy represent good value. If they do, I’ll do well.

That’s the thing about the share market – you don’t have to know every answer to every question – you only need to take action when you have a high level of confidence that your analysis is correct. There’s no penalty for skipping a question that’s simply too hard.

Champion hurdler Sally Pearson doesn’t give up athletics because she can’t win the high jump – she just focuses on her event. Does it make her victory any less worthwhile because there other gold medallists in other events?

Value abounds
On the basis of earnings alone, many companies in today’s market represent good value and a subset of those are excellent value. It’s my firm belief that judiciously selecting a portfolio of quality companies at today’s prices may well form the basis for market-beating returns in the years to come.

It’d be well enough for investors if the story ended there. But there’s a kicker. Not only are some companies trading at bargain prices, many are sporting very attractive dividend yields as a bonus.

Growth or income? Both, thanks
The bonus for both growth and income investors is that today’s combination of a low earnings multiple and a high dividend yield on many stocks allows them both to choose the same companies. Not only that, I think it’s likely that the growth-focussed investor will get a healthy income stream as a bonus to reinvest, and the income investor will not only receive their income, but will have good capital appreciation as a windfall. It’s the best of both worlds.

A word of warning is appropriate here – you cannot be successful by investing only through the rear vision mirror. You must ensure that both earnings and dividends are sustainable, and preferably growing. Often high trailing dividend yields are red flags – the market has downgraded a stock based on a likely fall in earnings and/or dividends.

There is value, however, in sorting the wheat from the chaff. While companies like Woolworths Limited (ASX: WOW), QBE Insurance Group (ASX: QBE) and Wesfarmers Limited (ASX: WES) haven’t each exactly shot the lights out with revenue and profit growth, all three companies have dominant market positions, are run by capable and proven management teams – and each sports a trailing dividend yield of over 5%.

On top of that, both Woolworths’ and Wesfarmers’ yields are fully-franked – and while QBE’s yield is only partly franked, the yield of over 10% more than makes up for it being less tax-effective.

All three are very likely – in my opinion – to be much stronger and more profitable in 5 years than they are today. If I’m right, that means a growing dividend yield and an increasing share price, as investors are prepared to pay more for the higher profit.

Foolish take-away
I don’t know when the share prices are likely to start their journey back upwards. Maybe yesterday’s jump is the beginning of the recovery, or maybe it’s a dead-cat bounce and we’re stuck at these levels for a while.

Comfortingly, buying well – and with a long term view – means you don’t have to get the timing right. Buying companies that also sport high dividends means you also get paid to wait – and then paid even more as profits (and dividends) grow and the share price inevitably catches up.

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Scott Phillips is The Motley Fool’s feature columnist. Scott owns shares in Woolworths and QBE. The Motley Fool has a stonking disclosure policy. This article has been authorised by Bruce Jackson.

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