Why buying ASX dividend shares based only on yield can deliver poor results: fundie

Income investors would do well to look beyond a stock’s trailing dividend yield.

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A man with a wry smile on his face is shown close up behind ascending piles of coins as he places another coin on top of the tallest stack representing the rising Brickworks dividend yield

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Key points

  • ASX dividend shares are in focus amid rising inflation
  • Income investors should look beyond just the current trailing dividend yield
  • Long-term shareholders may be getting higher yields on their investment capital than current share prices reflect

ASX dividend shares have come back into sharp focus for many investors in 2022.

That’s largely because fast-rising inflation is putting pressure on central banks to tighten monetary policies.

And higher interest rates tend to drag on the rapid share price rises that many growth shares enjoyed over the previous two years. Share price gains that came amid historically low-interest-rate environments.

With the outlook for growth shares in 2022 muted in comparison, investors are keen to see some extra income dropping into their bank accounts, courtesy of ASX dividend shares.

But buying companies purely for their attractive dividend yields can be a mistake.

Look beyond ASX dividend shares’ current yields

According to Rudi Minbatiwala, co-portfolio manager of the First Sentier Equity Income Fund (quoted by The Australian Financial Review):

We think income investors can benefit from changing their mindset about equity income investing. Attractive income from equities is delivered through the interaction of yield and growth over time, not yield alone.

Minbatiwala points to ASX dividend share REA Group Limited (ASX: REA) as a prime example. The global online real estate advertising company pays a fully franked yield of 1.1%.

A stock like REA Group is a prime example – its strong earnings growth over more than a decade has delivered an exceptional, growing dividend income stream to investors over this time. But this income stream is often ignored because income investors mistakenly only look at the stock’s low dividend yield as a function of the current share price.

I know this may sound counterintuitive to some, but thinking about dividend income on a yield basis can deliver poor income on a dollar basis over the long term.

Indeed, atop its reliable dividend stream, the REA Group share price is up 137% over the past five years. And, despite tumbling 20% so far in 2022, the share price has gained 973% over the past decade.

“We look for the best investment ideas, regardless of dividend yield, to maximise the long-term income from dividends, and also use options to deliver the near-term income needs,” Minbatiwala said. “This widens the opportunity set of what we call income stocks.”

Current yields may not reflect your actual yields

Minbatiwala added that the First Sentier Equity Income Fund also “quite likes” building materials company, James Hardie Industries PLC (ASX: JHX).

The ASX dividend share pays a 1.2% yield, unfranked.

“While it does not pay a large dividend relative to its current share price, the most recent dividends are quite significant compared to when we first purchased the stock,” he said.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended REA Group Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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