Investing Basics: Income from Equities
Investing for income has come to the fore in the low interest environment that has existed in the UK for the last decade and all the more so since 2015 pension reform removed the requirement for those reaching retirement age to purchase an annuity – writes Christian Leeming
Companies tend to announce the dividend they are proposing to pay at the same time as they reveal their earnings figures.
A company pays dividends out of cash at hand but a comparison between the dividend per share it pays and its most recent earnings per share can give an insight into the way the company is paddling beneath the surface.
If a company’s earnings per share is more than double the dividend it declares, that is a sign that the company can well afford to reward its shareholders; it is banking a similar amount to that being paid away in dividends.
However, if a company is paying away more than it is earning per share, thereby eroding its cash reserves or indeed borrowing to finance a distribution, that is not generally considered a good sign.
A metric for measuring and comparing the relative size of company dividends is the Dividend Yield which is the dividend as a percentage of the company’s share price.
‘How can you sell this for such a low price?” I say, “Because it’s total crap”‘
In a broader context, does the £100 you have invested in Acme Cleaning Co give you a better return than you could achieve from the more certain return of buying a bond or the absolute certainty of the interest earned in a savings account?
If not, then that may not be a sound investment and even if it does pay you more, is the difference enough to warrant the additional risk of investing in a single stock?
Although historical data can be an indication of the size and probability of future distributions, dividends are far from guaranteed; some companies may pay no dividend and those companies that have traditionally weighed out will have their distribution policy under constant review.
Investing in individual equities is at the gamey end of the risk/reward curve – get it right and it is hard to match the returns that can be achieved by investing in any other asset class; get it wrong and your entire investment can be wiped out if, for example, the CEO of your chosen company does ‘a Ratner’.
In an undoubtedly intentionally light hearted speech to the Institute of Directors on 23rd April 1991 Gerald Ratner , Chief Executive of high street jewellers, the Ratner Group, commented:
‘We also do cut-glass sherry decanters complete with six glasses on a silver-plated tray that your butler can serve you drinks on, all for £4.95. People say, “How can you sell this for such a low price?” I say, “Because it’s total crap”.
‘the value of the group that once bore his family name fell by £500 million’
He compounded this by going on to remark that some of the earrings were “cheaper than an M&S prawn sandwich but probably wouldn’t last as long.”
Ratner’s comments have become textbook examples of the folly in contemptuously mocking customers and as a result the value of the group that once bore his family name fell by £500 million.
Those investors that had diligently researched a group consisting of Ratners, H. Samuel, Ernest Jones, Leslie Davis, Watches of Switzerland and over 1000 shops in the USA could have been excused for having invested with confidence and should justifiably have looked forward to handsome (gold plated?) returns in the future.
Should have been a contender, but then came an own goal that doesn’t appear in any handbook about things the DIY investor should look out for; an object lesson in the need to spread your investment risk – not just between asset classes, but also within them.