Dividend Resilience in Tough Markets
I have implemented an investment philosophy for the last 20 years that is straightforward and easy to understand: Invest in a diversified portfolio of financially strong, cashflow-strong companies that pay an attractive and growing dividend.
I believe that if you can identify 25 to 30 of these companies and buy them at reasonable valuations (they are never ‘cheap’), then if we just leave them alone, they will produce an attractive return over the longer-term. It’s not exciting, and the individual companies are unlikely to suddenly go up 50% (unless maybe they are the subject of a takeover bid), but the financial mathematics are compelling. If you start with a dividend yield of 3% for the portfolio and it grows its dividends by 7% annually, then (ignoring charges and tax), you will receive over 10 years a return of 41%, with no capital gains built in.
And the dividend yield on the portfolio in 2032 would be 5.5%.
If you were to buy a German 10-year bond today and hold it for the next 10 years, your return would be 0.8% p.a. per annum, or just 8% over the entire period and this in an environment where one year’s inflation is likely to eat up most of that 10-year return. Note that if you had bought the 10-year German bond at the start of 2022, you would today have a market value loss of about 8%.
Some of these companies are regarded as boring, but they are very reliable. Let’s take Johnson & Johnson as an example. It has just announced its 60th consecutive year of dividend increases and its 2022 dividend is double that of ten years ago. This is the type of boring and reliable company investors should not discount. If you could get an additional modest capital gain, then in our view you are looking at mid to high single digit annualised returns over the longer term, and a ‘sleep easy at night’ portfolio. Johnson & Johnson’s total return over 10 years in US$ (dividends plus capital gains) is over 14% per annum, or almost triple your initial investment (Source: Bloomberg).
The consistent dividend growth element is key; the effect of compounding the dividend increases makes a big contribution to the longer-term returns.
While 2021 was probably a less difficult year for everyone compared to 2020, there were many tough hurdles for companies to overcome – the ongoing pandemic and associated restrictions, semiconductor chip and other key shortages, inflation rising sharply, etc.
For the Global Equity Income Fund, the below chart shows dividend growth in 2021 by holding, which illustrates the resilience of our philosophy and portfolio of financially-strong companies:
Of the 27 holdings, there were no dividend cuts, and only two companies had no dividend growth (Samsung and Unilever). The three French holdings (LVMH, Cap Gemini and Vinci) had a kind of solidarity pact in 2020 to reduce dividends, and thus had outsized dividend growth in 2021 as they fully restored their dividends plus some growth. The average dividend growth for 2021 was 12%, and over 8% excluding the three French outliers – a testament to our holdings’ business resilience, financial strength, and dividend commitment.
Despite the war in Ukraine, sharply higher inflation and rising interest rates, I am confident that the Global Equity Income Fund will see yet another year of dividend growth of about 6% to 8%.
Dividend growth is an excellent long term investment strategy. In the shorter term, sometimes it goes out of fashion, but it seems back in vogue again in 2022, as investors look to protect themselves against geopolitical uncertainty, longer-lasting inflation, rising interest rates and bond yields, and switch out of former high growth ‘no-brainers’ coming unstuck such as Netflix, Facebook and Paypal.
Perhaps, occasionally, past performance is not an unreliable guide to future performance!
Pramit Ghose is Global Strategist with Cantor Fitzgerald Ireland.