book is divided into four main sections: (Parts A-D) basic information on how dividends are set and by whom; how to analyse companies to maximise the yield on your investments; how to find companies that fit your investment criteria; and how to build your own portfolio using the knowledge that you have gleaned from the first three sections.
Chapters are arranged to lead investors step-by-step through the whole topic of investing for dividends. New and less sophisticated investors will particularly benefit from reading from start to finish. Even those with little knowledge of how the stock market works will feel competent to begin investing by the time they are half way through the book.
You can also use The Dividend Investor as a reference work. In particular, the chapters on the key figures and ratios that investors use to choose companies that fit their portfolios should be fully understood.
Supporting website
The accompanying website for this book can be found at: www.harriman-house.com/thedividendinvestor
Acknowledgements
Thanks for invaluable insights into how companies set and pay dividends are due to:
Paul Roberts, finance director, Wynnstay
Kulwant Singh, finance director, computer software supplier Delcam
Shatish Dasani, finance director, TT Electronics
Duncan Jeffery, marketing manager, Hargreaves Lansdown
and to Zoe Biddick and Katie Tzouliades of financial public relations company Biddicks.
Also thanks to Stephen Eckett of Harriman House for supplying extensive company data as well as for editing this book with his customary courtesy and perspicacity.
Why dividends?
There are two major reasons for investing:
1 to produce income
2 to store wealth for some time in the future.
It is very important to recognise the remarkable power of dividends. Newspapers feed the public with daily doses of how share prices rise and fall, often commenting on how billions have been added to or wiped off the stock market or how shares in some company or another have gained millions in a single day because of one item of good news.
It is easy to be seduced by these dazzling figures that foster the notion that the stock market is all about making a fast buck in a gambler’s paradise, especially in a bull market when all eyes are on rising shares prices.
In fact, the real money is made through solid investments that pay regular, rising dividends. The greater part of total returns for share investors over time will come from dividends, not capital gains. And when markets are falling, your only gains are likely to come from dividends.
To demonstrate the importance of dividends we can look at figures produced by the Barclays Equity Gilts Study, which showed that £1,000 invested in shares at the end of the Second World War would have been worth £57,210 by the end of 2009.
However, had we reinvested the dividends our pot would have ballooned to a massive £924,600.
So unless you are a very short-term trader, you should be investing for dividends as part of any strategy for capital growth. Companies paying gradually improving dividends are the ones that will see their share price rise over time and the income from dividends will help to offset any capital losses you may suffer.
Even short-term investors should consider running a separate long-term investment portfolio as a back-up. Therefore almost every investor should be a dividend investor.
It is possible to invest by putting your money into a fund such as an investment company or trust. You can find out how to do this in chapter 24. However, you are abrogating responsibility for your finances to a fund manager who cannot possibly know what you want from your investments and what risks you are prepared to take.
The performance of individual funds can vary enormously from year to year. The one constant is that the manager has to be paid out of your money. There is absolutely no reason why you cannot make sensible investment choices yourself, retaining control of your own destiny. Even if you do not perform quite as well as the fund manager, you will come out ahead because you are not paying the fund’s fees.
With the help of this book you can compete easily with the City professionals, retaining the flexibility to invest as, when, and where you choose.
Chapter 1. Companies and Dividends
The purpose of companies – to pay dividends
Let us be quite clear: the whole purpose of companies is to pay dividends. It goes like this:
1 a company is set up
2 the company makes a profit
3 the owners share the profit
4 we all live happily ever after.
The payment of dividends is, or should be, the raison d’être of all companies whose shares are quoted on any stock exchange. Dividends are the reward paid to shareholders who have invested their money in the business.
Yet in a sense dividends come last in the pecking order. They are funded out of what is left over after a whole range of bills and obligations have been met, such as:
staff wages
trade creditors
tax
interest and repayments on bank loans
pension fund contributions
bondholders
cash to meet day-to-day needs (working capital)
investment in the company.
There are two factors that affect whether a dividend is paid at all:
1 The company must have made a profit, either in the current or in previous years.
2 The company must have some cash to fund the dividend.
Companies do not normally pay out all the profits as they arise. Some cash is retained to fund the day-to-day operations of the company and some is held to fund expansion or new plant and machinery. Profits that are thus retained in the business build up in what are known as ‘distributable reserves’, so called because this is the amount of cash that can legally be distributed to shareholders in dividends.
If the company makes a loss, that will reduce the size of the distributable reserves. If losses persist and all the distributable reserves are used up, the company cannot pay dividends. Any accumulated losses must be
