Dividends are a wonderful thing.
A dividend is when a company decides to distribute some money to shareholders, they are very similar to gaining interest on a savings account or term deposit. Dividends often happen on a regular basis, commonly every 3, 6, or 12 months. Dividends often come out of a company’s earnings, although some companies decide to take out loans to pay dividends.
A company’s board members will decide if they wish to pay a dividend and how much it will be. There are several reasons for a dividend- perhaps a company has more money than it knows what to do with, or maybe they want to make shareholders happy and make the shares look more attractive. Companies only start paying dividends once they have matured and are in a more comfortable position with little need/room for growth.
Whatever the case for the dividend, they provide a secondary means for investors to gain money, with the primary being the increase in the share price. In New Zealand, companies tend to pay out significant proportions of their earnings in dividends, compared to other countries. For example, the gross dividend yield of the FNZ (Smartshares NZ Top 50) fund is currently 3.61%, while for the USF (Smartshares US 500) Fund it is 0.40%. This shows in the returns of the sharemarkets. The NZX All Total Return index has increased by an average 9.6% per year for 25 years, however, this number drops to 3.7% per year when excluding dividends [1]. Switching to the US, the S&P 500 has returned a similar 9.3% per year, but the majority of that has been from increases in share prices.
Dividends provide investors with a steady stream of income, without having to sell their shares. This is very important for people who are retired, as they can live off the dividend income to supplement any superannuation/pension. Dividends are also helpful for younger people to help increase their earnings. Let’s take a look at the chart below for a retirement example. This model assumes-
- You spend $50,000 in expenses every year.
- You have no superannuation or other source of income.
- Your holdings do not change in value.
The blue line shows what happens if you retire with $1 Million in cash and just use what you need. Doing this, you will run out of money after 20 years. However, if you were to have a stable investment portfolio that provided a very achievable 2% in dividends every year (orange line), you would be able to go 25 years before running out of money. In the case where you retire with $2.5 Million and a 2% dividend rate (grey line), you will be able to cover all your expenses with just dividends and never run out of money.
Something alluded to above, is that dividends tend to be paid by companies with low growth prospects. If a company believes it can make more money later by spending money now, it won’t pay dividends and will instead invest in growth. Look at NZX heavyweight The A2 Milk Company as an example. Despite starting in 2007 and being one of the largest companies on the NZX, ATM has never paid a dividend. This is because they are a company that wishes to improve their business and so will use their earnings to build more factories, produce better products and gain a wider market. Perhaps in 10- or 20-years, ATM will decide that it has grown enough and will start paying a divided. Compare this with Meridian Energy, which is a well-established, stable company with less growth investment opportunities. Due to this MEL pays out a gross dividend of 5.37% currently [2]. This means that when looking to invest, there is a trade-off between growth and dividends.
Here are some of my favourite dividend companies/funds-
- Meridian Energy (MEL)
- Smartshares NZ Property Fund (NPF)
- Smartshares NZ Top 50 Fund (FNZ)
- Smartshares NZ Mid Cap Fund (MDZ)
- NZ Core Equity Trust (a.k.a. Smartshares NZ Core Fund)
Disclaimer- I am not advising you to buy/sell/hold any of these on my word. These are simply companies/funds that I like and may not be suitable for you and may not be good investments. I recommend you do your own research and/or talk to a professional investment advisor. I own shares/units in the NZX 50, S&P 500, ATM, MEL, NPF, FNZ, MDZ and NZ Core Equity Trust.
References
[1] M. Lister, "Why you shouldn't underestimate dividends," Craig's Investment Partners, 15 June 2020. [Online]. Available: https://craigsip.com.
[2] Sharesies, "Meridian Energy," 13 September 2020. [Online]. Available: https://app.sharesies.nz/.
