INSIGHTS

Dividend growth is one of the key reasons for investing in shares, and the ability of companies to generate growth in income over time is what stands shares apart from all other investments.

Companies that have an established track record of consistently lifting dividends tend to be higher quality with good financial discipline, robust cash flows and a track record of profit growth.

A strong relationship also exists between a company’s share price performance and the dividends they distribute. While a company’s share price can deviate from growth in its underlying dividend in the short-term, history has shown that over time the two generally converge. Bankers Investment Trust is a prime example of this.

As evident by the fluctuation in its share price (see previous chart), Bankers has not been immune to global events such as the 1973 oil crisis, the 1987 share market crash, the 1990 oil price shock, the 1997 Asian financial crisis, the dot-com bubble in 2000, the 2008 global financial crisis, and the recent COVID pandemic.

However, Banker’s dividend over this period has been far more resilient. The fund manager’s focus on investing in companies that provide both income and capital growth has resulted in an enviable 55-year track record of consistent dividend growth.

Over this period, Bankers has grown its dividend by an average of the 8.4% pa. This is in line with the 9.0% pa growth in its share price. In dollar (or pound) terms, £10,000 invested in Bankers in 1966 would currently be worth £1,288,312.

More importantly, the income stream that this investment generates would have grown from £290 a year in 1966 to £26,558 a year today. This annual dividend stream is more than 2.6 times the original £10,000 investment and is equivalent to a 266% yield on cost. This shows the true power of a growing dividend stream. While Bankers share price has at times deviated from growth in the underlying dividend, history has shown where dividends go the share price tends to follow.

Dividends tend to be less volatile than share prices

Over time, high quality dividend paying companies have provided investors with a higher total return for a lower level of risk. While share prices are driven by a multitude of factors, one of which being market sentiment, in their purest form dividends reflect a company’s underlying performance - did the company grow its profit during the year and how much of that profit has the board elected to retain in the business to support future growth versus pay-out to its shareholders in the form of a dividend.

This makes dividends less volatile than share prices and is why we recommend investors place a greater focus on growth in the income stream generated by their portfolio rather than the daily fluctuations in the value of the portfolio. Companies that have been able to consistently grow their dividends over time have also proven to be more resilient in a downturn than the broader market. This reinforces the importance of diversification and holding a portfolio of high-quality defensive companies with a track record of growing dividends over time.

Don’t ignore low dividend yield stocks

New Zealand investors are spoilt when it comes to the dividend yields offered by New Zealand listed companies. The New Zealand share market is what is referred to as high yield market. The NZX50 Index trades on an average yield of around 4.5%, whereas the typical yield from markets offshore is closer to 2.0%.

The high yield nature of the New Zealand market reflects several factors including the sector in which a company operates, the size of the market and the growth opportunities within that market.

However, lower dividend yield stocks should not be ignored. While the income provided by these companies may be lower than that found elsewhere, the ability of these companies to grow the income stream they pay overtime is a key attraction.

With many of us likely to spend 20, 30 or even 40 plus years in retirement, ensuring you have a good mix of higher and lower yield companies in your portfolio is a must. This will ensure the portfolio is generating both income today as well as providing income growth for the future, which is essential to keeping inflation from eroding the spending power of your money.