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The importance of dividends

And the wonder of compounding.

This has been the worst year on the JSE since the 2008 global financial crisis. Unless something extraordinary happens in the next few weeks, 2018 will be the first year in a decade that the market has delivered a negative total return.

Even through the lean period since 2014, the FTSE/JSE All Share Index (Alsi) has at least managed to eke out a positive performance each calendar year. The return of 2.6% in 2016 was, until now, the lowest figure since the drop to -23.2% in 2008.

It is worth bearing in mind, however, that the positive return in 2016 was entirely due to dividends. Without them, the Alsi actually fell from 51 324 to 50 653 over the course of the year.

There is a slightly longer term story here too. Over the last five years, reinvesting dividends would have been responsible for more than half of the return from the local market.

Where there is still growth

Figures provided by Johan Gouws, head of institutional consulting at Sasfin Wealth, show that without dividends the Alsi would have grown just 18.75% in total since 2013. Adding dividends into the equation lifts that total growth to 37.7%.

As Dave Mohr and Izak Odendaal from Old Mutual Multi-Managers noted last week, it is also significant that even as share prices have struggled over the last few years, dividends have still grown.

“At an index level, dividends have grown 14% per year over the past 20 years,” Mohr and Odendaal pointed out. “The most recent five-year period, with weak commodity prices and a tough domestic economy, has still seen dividends grow 8% per year.”

Read: Don’t give up yet

According to FTSE Russell, the dividend yield on the Alsi was at 3.64% at the end of November. That is near historical highs. The yield on the market was at 4.1% when it bottomed in 2013.

As the table below shows, even if dividends grow at just 10% per year from here, the nominal value of the yield from a R1 000 investment in the Alsi will almost match the yield of 6.5% one could currently get from a money market account within six years.

Dividend yield versus money market yield
  Dividends Money market
  Capital Yield Capital Yield
Year 1 R1 000.00 R36.40 R1 000.00 R65.00
Year 2 R1 000.00 R40.04 R1 000.00 R65.00
Year 3 R1 000.00 R44.04 R1 000.00 R65.00
Year 4 R1 000.00 R48.45 R1 000.00 R65.00
Year 5 R1 000.00 R53.29 R1 000.00 R65.00
Year 6 R1 000.00 R58.62 R1 000.00 R65.00
Year 7 R1 000.00 R64.48 R1 000.00 R65.00
Year 8 R1 000.00 R70.93 R1 000.00 R65.00

Regardless of where share prices go, if you are reinvesting those dividends, you are buying more shares, and therefore increasing the yield you receive. Essentially, you are compounding your return using the cash that companies are paying out to shareholders.

The bigger picture

The impact of this is even greater when one removes the biggest contributors to market performance in recent years. Over the past three years, the Alsi has grown 5.99% at an index level, excluding dividends. However, if one strips out the contributions of Naspers, Richemont, Anglo American, BHP Billiton, Sasol and Mondi, everything else is actually -5.03% down.

Reinvesting dividends changes that picture. Even stripping out those top performers, the Alsi is positive over the last three years when dividends are reinvested.

The graphs and tables below illustrate the impact of dividends in more detail.

Source: Sasfin Wealth, FactSet

Source: Sasfin Wealth, FactSet

Dividends have therefore clearly been a saviour for local investors, but it’s not only on the JSE where they play such a significant role. Earlier this year, global asset manager Schroders looked at the impact of dividends on returns from the MSCI World Index over the last 25 years.

“If you had invested $1 000 on 1 January 1993 in the MSCI World, the capital growth would have produced a notional return of $3 231 by 7 March 2018,” Schroders noted. “Annually, that represents a growth rate of 5.9%.”

This figure almost doubles when dividends are taken into account.

“By reinvesting all dividends, the same $1 000 investment in the MSCI World would have produced a notional return of $6 416, representing annualised growth of 8.3%.”

That difference of 2.4% a year compounded over 25 years is meaningful.

“Dividend reinvestment is one of the most powerful investment tools available,” noted Schroders fund manager Nick Kirrage. “As our research shows, the potential difference to the rate of return [that] dividend reinvestment makes could be substantial. Over time, those seemingly small amounts reinvested can grow into much bigger sums if you use them to buy even more shares that pay dividends in turn.”

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I have about 30 shares, of which Vod and PSG have been the most consistent in growth and high div. payers. Any suggestions?

With the financial risk that Eskom is posing to SA, I HOPE NOT that the Fin.Min in his next Feb 2019 Speech will fiddle with the current 20% DWT-tax.

The answer is obvious, you can only get tax from those who have money.

I think this article may have a few flaws in it, namely when dividends are paid out they would be directed to your trading account and it is subject to DWT. Then to buy additional shares in the company you would suffer brokerage and MST etc. etc. and if you wanted to invest the full amount of dividends into the same counter you would invariably end up purchasing odd lots.
So at the end of the day I don’t know whether this really works especially if you have a portfolio of 20 odd shares. To my mind it is easier to leave the dividend payouts in your trading account and then when sufficient funds exist buy into your existing portfolio or add to your portfolio to keep some semblance of diversity

Indeed, it makes (practical) sense to me. Maybe Patric meant by “dividends reinvested”, in a practical sense, when sufficient Div payments (after DWT) have accumulated in one’s trading account over time, then it can be manually, invested back into equities.

Btw, which trading platform are you using? 🙂

In general i also prefer to take the cash and then make my own decision about where to direct it. But i do like when a company gives you the option to rather take more shares in lieu of cash. Occasionally thats a good deal too, especily if you are building the portfolio still and dont need to draw an income off it yet.

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