By Fidelity, 20 December 2013
‘Equity income’ funds focus on dividend-paying shares. Unsurprisingly, they are popular with investors who need a regular income, but they can also be a great way of aiming for long-term capital growth as well. Here are six reasons we think it’s worth exploring the opportunities.
1. You can access a wide range of opportunities
Although the UK is well recognised for its dividend culture, many other countries and regions also pay good dividends – including some you may not expect. For example, almost nine in ten companies in the MSCI Emerging Markets Index paid a dividend in 2012. What’s more, a number of countries in this category, such as Brazil, actually have laws requiring companies to return some of their profits to investors.
2. Dividend yields are currently above average all over the world
The dividend yield tells you how much income you can expect from a share, as a proportion of a company’s current share price. (See the box below for more information.) When yields are higher, you get more income for your money – and, at the moment, yields are above the average for the last 15 years in all the major markets. Globally, the current figure is 2.8%, compared with an average of just 2.2%. Of course, it’s important to remember that this isn’t a guide to future performance.
3. In some regions, dividends are even beating the interest from bonds
With government bonds currently paying investors a historically low income, company shares in many cases pay a much higher income than this traditional source of a secure yield. However, what is probably less well known is the fact that shares can offer a higher income than corporate bonds as well. Almost half of European companies currently have a dividend yield that is above the average yield from European corporate bonds. 1
4. Reinvested dividends drive long-term growth
While equity income funds can be a great way to generate a regular income, reinvested dividends have the potential to make another important contribution to investors’ savings. Research shows that it takes an average of just five to six years for reinvested dividends to overtake capital growth as the main source of a stock’s total return. 2
If you look at longer-term performance, the figures become even more impressive. For example, the Barclays Equity Gilt Study in 2011 showed that $100 invested in the US stock market in 1925 would have grown to $9,524 by the end of 2008 if dividends were paid out – but it would have reached $302,850 if they were reinvested. Please remember that past performance is not a guide to future returns.
5. Dividend payers can also be good performers
There’s a widely held perception that dividend-paying companies lack the growth prospects of businesses that don’t pay dividends. However, research suggests the truth is very different. Earnings growth is actually fastest with companies that pay high dividends – and they tend to outperform in the good times (bull markets) as well as the bad (bear markets).
One possible explanation is that dividend-paying companies are less likely to become overvalued by investors. They are less prone to getting caught up in bubbles, so their share prices don’t rise suddenly and then crash back even further. Instead, they just tend to put in steady performance year after year.
6. Dividends can indicate a lower level of risk
If you want to invest in the stock market, but don’t want to take on too much risk, a dividend-based strategy could be a good option. Companies that pay consistent dividends normally have good cash flow and strong balance sheets. Many are internationally-known organisations selling products that are household names. To put it another way, dividend-paying companies tend to be stable, profitable businesses that are well run in the interests of their shareholders.
Explaining dividend yields
Dividends are normally shown as a certain amount per share. For example, if a company pays a 10p dividend and you have 100 shares, you would receive £10. Dividend yield helps you compare the dividends from two companies with different share prices. For example, imagine two companies paying the same 10p dividend. Company A has a share price of £1, while for company B it is £2. The dividend is the same, but the dividend yield is very different. On company A, you are receiving a 10% yield on your investment, while on company B it is 5%.
US Stock market performance over the last five years
Past performance is not a guide to future returns.
Source: Datastream. Performance of S&P 500 index with and without income reinvested as at 30.11.13
1 Source: Datastream, Goldman Sachs Global ECS Research. Euro Vision – Equities growing up, European Strategy Outlook 2014, Goldman Sachs, 20 November, 2013.
2 Sourced from the Brandes Institute based on stock market data from 1926–2003.
The value of an investment can go down as well as up so you may get back less than you invested. Overseas investments are subject to currency fluctuations and emerging markets may be more volatile than established markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. This information does not constitute investment advice and should not be used as the basis of any investment decision, nor should it be treated as a recommendation for any investment.