In this new article, continuing with the cycle of articles on financial literacy, we will try to explain what dividends are and why they may be important when it comes to obtaining attractive returns on our investments. Let’s begin by explaining the concept: since equity investments don’t mature, companies distribute a portion of annual profits in the form of dividends in order to maintain shareholder loyalty. In this way, regardless of whether the share price rises, we can receive a periodic payout on our investments, even though it is not guaranteed that every company determines what its dividend policy will be to give clear guidelines to its shareholders.
That said, dividend payments are not currently top of the list of investor preferences, as conservative investors finally have the option to make deposits or purchase treasury bills, while more aggressive investors are captivated by the rises in the technology sector and crypto-assets (with Nvidia and Bitcoin surging more than 70% so far in 2024). Nevertheless, we must always bear in mind that investment is a long-distance race littered with obstacles, not only economic and geopolitical ones, but also in terms of human behaviour.
Indeed, it is precisely this herd-like behaviour of ours that can perhaps cause us to overlook the medium-term benefits of investing in ‘boring’ companies that maintain an attractive dividend payout to shareholders. To illustrate this, we need only look at the performance of the Ibex 35 since the 2008 financial crisis. If we calculate the revaluation of the index, we see that it has not yet recouped the levels of late 2007—in fact it is still 30% lower; but if we add the dividends paid out during the period, the picture changes dramatically and the losses of more than 30% translate into a profit of more than 45%.
But as ever, we must not be carried away by first impressions, and careful analysis is required when investing in dividend companies. In other words, we should not be fooled by the high dividend yields of some companies, because this is merely a snapshot of the situation. What we must analyse is their consistency (i.e., whether or not dividends have increased in recent years), how they performed during the pandemic and, in short, what is the shareholder remuneration policy followed by each company. Without wanting to get too technical, a very important variable to keep an eye on is the payout ratio, which tells us what percentage of earnings is distributed to shareholders as a dividend. If this ratio is high (say over 80%), we need to be aware that in the event of a fall in profits the dividend may be cut, whereas with a more even ratio (40–60%), the company will be able to keep the dividend payout more stable, even in times of moderate profits.
Ultimately, when we are considering our investments, we must not forget to diversify, and perhaps give some space to assets with an attractive and consistent dividend yield. As Aesop told us in Ancient Greece with the fable of the grasshopper and the ant, winter (even with climate change) always comes and we must be ready to endure it and not die trying.
Diari d’Andorra 10.04.2024