Investors are often told by financial planners to focus on 'blue-chip high-dividend paying stocks'. Countless articles have been written aimed at self managed super funds (SMSFs) and small investors, extolling the virtues of buying the high-yielding companies to provide a reliable income. But is this the best way to invest, especially for the longer-term investor?
An analysis by the team at the Australian Financial Review looked at the example of SMSF favourite Telstra Corporation Ltd (ASX: TLS) versus TPG Telecom Ltd (ASX: TPM) between 2004 and 2014. The table below shows the comparison of the two companies.
|
Telstra |
TPG Telecom |
|||
|
2004 |
2014 |
2004 |
2014 |
|
| Share Price |
$4.82 |
$5.25 |
$1.12 |
$5.32 |
| Dividend Yield (%) |
5.4% |
5.3% |
1.3% |
1.4% |
| Value of $100 Investment |
$100.00 |
$109.00 |
$100.00 |
$475.00 |
| Dividend ($) on $100 Investment |
$5.40 |
$5.81 |
$1.25 |
$6.70 |
| Capital Gain |
8.9% |
375.0% |
||
| Dividend Growth |
7.5% |
435.8% |
||
| Dividend Yield (%) on Initial $100 Investment |
5.8% |
6.7% |
||
The table shows what would have happened to an investor had they bought $100 of Telstra and TPG Telecom in 2004. Analysis of the table essentially discusses the 'value investing' implications of each company, so stick with me.
In 2004, Telstra paid a much larger dividend than TPG but in doing so paid out over 80% of earnings to investors, compared with just 30% for TPG. These retained earnings gives management of TPG more money to spend on growing the business. TPG's strategy of retaining earnings has been consistent for the majority of years between 2004 and 2014 and has allowed the company to grow earnings from 4.5 cents per share in 2004 to 18.8 cents per share in 2014. Telstra meanwhile, has paid out the majority of earnings to shareholders and earnings have actually gone backwards, from 32.6 cents to 30.6 cents in the same period of time.
As a result, while Telstra shareholders have received higher dividends over the 10-year period, TPG as a company has grown much larger and grown the investor's initial $100 investment into $475. Additionally, while the yield of 1.4% on the current share price is low compared to Telstra, as the investor bought the shares 10 years ago, the yield on purchase price is actually above that of Telstra.
It should be noted that Telstra has retained a more significant percentage of earnings lately and is expected to grow earnings in the coming years, hopefully leading to better capital growth for investors.
Foolish takeaway
Many more hundreds of words could be written on the table above, however the main takeaway is that if a company is paying out the majority of earnings then it has limited scope to meaningfully grow over time. The best companies, those favoured by Foolish investors, have the ability pay out a decent dividend yield AND retain a good portion of earnings to grow the business over time.
