Dividends have made headlines recently due to Labor’s proposal to remove refunds of excess franking credits to low and zero tax paying investors. Putting these proposed changes aside, I agree with Anton that dividend income will always remain an important element to consider when constructing an equity portfolio.

Below is a summary of Anton’s three key reasons why dividends have always been and will continue to be important for investors to consider.

Dividends are a more reliable source of return

Investment returns from an equity portfolio come from two sources, capital appreciation from the shares owned in the portfolio plus the dividends these shares pay. Analysis of the ASX300 over the past 20 years shows the total annual return was 8.3%. When breaking this total return down to income and growth, 4.4% came in the form of dividend income while the remaining 3.9% was delivered by growth in the value of the shares. In other words, 53% of the 20 year average annual return came from dividend income alone.

The level of dividends received are not impacted by movements in the sharemarket

Dividends depend on the underlying companies’ earnings, not the movement in share prices. This is important because it means that even during periods of sharemarket volatility, where share prices can fall, dividends from a well diversified portfolio should remain quite steady. History shows that during a sharemarket downturn, most high-quality companies continue to pay dividends. As long as you don’t sell during these periods of depressed share prices, no loss is actually incurred.

The dividend yield on stocks can act as a ‘safety net’ at times of volatility

The sharemarket can be a moody beast over the short term. With the benefit of hindsight, what turns out to be a minor issue can initially be perceived by the market as a major crises. This can lead to large scale and indiscriminate selling. Remember that the underlying earnings of a quality business should be unaffected during short term periods of panic. This provides the opportunity to purchase a stream of future dividends at a lower price and is reflected by a higher ‘dividend yield’ (calculated by dividing income by the share price).

Conclusion

Dividends provide sharemarket investors with a consistent part of their total return and can also act as a ‘safety net’ in down trending markets. Dividend income will remain an important factor when investing in the sharemarket, irrespective of the tax changes proposed by the Labor Party. This is because dividends are responsible for a stable part of equity returns through the delivery of real cashflow, no matter the market cycle. 

For access to the full article use this link “Why dividends are so important” By Anton Tagliaferro (09 May 2018).