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Cash on delivery

The economic outlook means dividends are providing an even greater portion of total return on equities. Gregor Watt reports

The role that dividends play in total investment returns is well known but with inflation still well above 4 per cent and dividend returns set to continue the record growth of 2011, investing with an eye for income is set to be even more important than usual.

The flight to safety has encouraged investors to opt for gilts and has seen yields drop to negative levels when the effect of inflation is taken into account.
Jupiter chief investment officer John Chatfeild-Roberts says: “Bonds issued by the UK and the US governments are in heavy demand as investors see them as a safe haven from Europe’s woes. But if you analysed them in the same way as you would equities, you might think differently.

“UK gilts are paying a yield of less than 2 per cent. This gives you no protection against inflation of 4.8 per cent, provides no dividend growth and is backed by a country with high debts and weak long-term growth prospects.

“The shares of healthy multinational companies with strong balance sheets that can maintain good dividends look far more attractive. Share prices may be more volatile in the short term but I would feel more confident owning a portfolio of high-quality income stocks such as Glaxo and Shell, which have attractive valuations and healthy dividend yields of around 4.7 per cent and 4.4 per cent, than I would holding the bonds of most supposedly triple-A-rated countries. Such dividends are decent compensation for any short-term ups and downs in price.”

Last year was a good year for investors in UK dividend-paying companies, with dividend payments up by 19 per cent and a record £67.8bn paid out, according to the latest Capita Registrars dividend monitor. The average yield on UK dividend-paying stocks was up to 4.4 per cent and returns were boosted by a high number of special dividends.

The good news for investors is that regular and special dividends are both predicted to grow this year.

Capita Registrars chief executive Charles Cryer says: “Record dividends are providing a real bright spot for investors against a gloomy backdrop of crisis in the eurozone and a stalling economic recovery in the UK.

“We are optimistic that dividends will make further progress in 2012, unless the eurozone sinks deeper towards collapse and leads companies to retrench at home.
“Expanding dividends mean the yield on equities looks remarkably attractive, although there are clearly risks to capital in holding shares, as with many other comparable asset classes. Special dividends have been the icing on the cake for 2011 and look likely to sweeten investors’ returns again in the coming year.”

Fundsmith managing director Terry Smith believes the importance of dividends as a contributor to total investment returns should not be underestimated.

He says: “Dividends are likely to provide a more significant portion of the total return on equities in the future than they did in the equity bull markets of 1982-2000 and 2003-07.

“Research from GMO LLC shows that, taking a longer view, during the period 1871-2009, dividends accounted for more than 90 per cent of total return on equities in the US market.

“Moreover, this is not just a US phenomenon. The same patterns hold true across a wide variety of global equity markets. For instance, across markets in Europe, 80-100 per cent of the total returns achieved since 1970 have come from dividends, combining yield and real dividend growth”.

Bestinvest senior investment adviser Adrian Lowcock highlights the impact that reinvesting dividends has on long-term investments.

He says: “By reinvesting the dividend, investors can boost returns substantially – £100 invested in equities at the end of 1899 would be worth just £180 in real terms without the reinvestment of dividend income. With reinvestment, the portfolio would have grown to £24,133 by 2011.”

As an additional benefit, he says dividend-producing companies tend to be defensively positioned and can help to ride out any short-term volatility.

“Companies that generate a regular dividend tend to be more defensively positioned, have good balance sheets and strong positive cashflow – and therefore are better able to ride through a recession.”

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