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    Why Dividends Matter to Long Term Investors

    The range of equity market participants, as you can imagine, is extremely broad. While there is a large group of participants that can be termed ‘long term investors’, there are many other people and institutions who aren’t long term investors.

    Participants who aren’t explicitly in the market for the long run partake for a variety of reasons including hedging out exposure to certain risks, profiting on short term trading opportunities, providing liquidity as a market maker, gaining exposure to South Africa or emerging markets (generally offshore investors), etc. For these investors the return generated from dividends typically won’t be their primary reason for making the investment.

    Asset managers and certain hedge fund managers are typically your long term investors. A large portion of the assets that they manage are generally getting invested for retirement, justifying a long term approach.

    One of the more credible ways of valuing a company is the discounted cash flow method that looks to discount all cash flows (read dividends) expected from a company into perpetuity. Managers then compare the value calculated to the current market value to see whether the company is under valued or over valued.

    Empirical research shows the dividend is an important driver in long term returns. The chart below shows that your return from dividends is around 70% higher than your real capital appreciation over time. Investors are often more interested in the capital return, but most of the capital growth can typically be ascribed to inflation in asset prices, and not real growth.

    Source: Cannon Asset Managers

    The initial dividend yield will therefore play a large part in determining whether the value ascribed to a company by a market is above or below your cash flow based valuation. The market’s current historic dividend yield is extremely low suggesting that the market is extremely expensive. This can be seen in the chart below.

    Source: Investec Asset Management

    While our view is that the market is overpriced, we don’t feel that it is as extreme as the dividend yield suggests for a couple of reasons. Anglo not paying a dividend in 2009 and skipping one now affects the ‘market dividend yield’ materially (around 0.5%), but share portfolios can still be constructed with decent dividend yields. The yield relative to cash is also now more attractive than when cash was yielding over 10%, making shares look slightly more attractive than when looking purely at the dividend yield in isolation.

    The key to remember is that while certain indicators can give you a good idea of what to expect the actual experience will generally be slightly different as other factors may be at play that aren’t fully reflected in the indicator. Another caveat is that broad indicators are not fail safe, particularly over the short to medium term.

    Enjoy your weekend.

    Take care,

    Mike Browne
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-03-12, 16:33:35, by Mike Email , 1 comment
    Trackback address for this post: http://blog.sharenet.co.za/htsrv/trackback.php/1713

    Comments, Trackbacks:

    Comment from: Nick [Visitor] Email · http://rapidqueen.com
    I have followed all things that you said. Thanks.
    PermalinkPermalink 2010-04-02 @ 00:04

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