Many share market investors are almost myopically focussed in the movement of the capital price of their share investments, especially so in times of abnormally high volatility like we are experiencing now.
This focus is encouraged by the availability and transparency provided by the daily trading of shares on public exchanges and the uninformed bleating by media financial experts.
We know the price of everything, but do we understand the value?
Other types of investments, for example, direct property or the ownership of small businesses, provide far less transparency over movements in the underlying investment value. As a result, for these investment types, the investor’s perception of performance is determined more by the profit or income being generated, rather than any short-term movement in the capital or sale value of the investment.
This is where too many share market investors miss the point. In the long term it will normally be the income stream that provides the bulk of return to an investor, not the capital gain.
The reason for the extent to which dividends account for the bulk of investment returns is not intuitively obvious. The distinguishing characteristic of dividend income is that it is expected to increase each period. Ignoring tax, a 5% quoted dividend return is exactly the same a 5% interest bearing return in year one. However, over time the dividend dollar amount gradually increases in size even though the dividend percentage may stay the same. The dividend percentage is payable against the inevitable growth in the value of the share. Simple compounding interest!
Not only does income represent a more important source of return for long-term share investors than capital price movements, it also tends to be a more stable source of return.
Firms tend to maintain dividend payouts even if they experience a temporary decline in profitability. There is evidence of this occurring in the current round of profit reporting, with global and local economic factors impacting on share prices and earnings, but relatively few companies announcing reductions in dividends.
Several Australian blue chip companies are currently priced with fully franked dividends in the 5% range, which may prove to be attractive for those investors willing to focus on income streams and “ignore” the unusually high level of day-to-day volatility in share prices currently being experienced
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This article is general in nature only and does not constitute or convey specific or professional advice. Formal advice tailored to your specific circumstances should be sought before acting in any of the areas discussed.