As usual, there were some very perceptive comments from Terry Smith of Fundsmith on dividends and income funds in FT Money on Saturday (6/10/2018). Many investors want income – for example to finance spending in retirement – so they invest in high dividend paying stocks. Some simply think that reinvested dividends will enable them to grow their portfolio value but this is a poor result in reality. As Terry explains it would be better if the companies retained the earnings and reinvested them. The maths shows the negative impact of the tax you pay on the dividends.
Terry bemoans the fact that income funds outsell all other types by some margin, even though in reality many have only a yield that is slightly higher than the average. Needless to point out perhaps that the funds he runs are not income funds. But that does not destroy the wisdom of what he is saying.
All that matters is total return. If a company can reinvest the generated profits with a good return, there is no good reason to pay them out as dividends; as Warren Bufftet’s Berkshire Hathaway has never done with great results. Retained earnings compound even faster if no dividends are paid.
A personal investor can always sell a few shares to generate a cash income if necessary, and generally at a lower tax rate than they would pay on dividends.
Companies can usually find projects or acquisitions that can generate good returns. There are a few exceptions of course. Incompetent managements who pursue mirages or make disastrous acquisitions are examples, but those are the kinds of companies you should be selling not buying anyway.
Today the stock market is falling yet again, with growth stocks badly hit. There can be a tendency to hold on to those boring defensive and high-yielding stocks in a market rout. But that is a mistake. For the same reason you probably should not have bought them in the first place, don’t hold on to them. A yield of 4%, 5% or higher does not offset the risk of share price decline. Just consider when you are cleaning out your portfolio today to get rid of the duds that won’t be generating high and growing profits in the future. That’s all that matters.
Incidentally I had a letter published in the Financial Times today on the subject of Brexit, which was very kind of them as I effectively criticised their editorial policies. It was headlined “Please – no more letters from moaning Remainers” and was in response to two previous letters from clearly biased correspondents. You can find it on the FT web site.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
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