In the 1950s and 1960s the hottest investment sector was electronics. In the
1970s it was conglomerates. In the 1980s New Zealand had an extraordinary
bubble in the shares of corporate raiders. In the 1990s, it was consumer
products, drugs, and most strikingly, technology companies - the dotcom
boom.
Each of these fads came and went but one thing was constant - everybody
bought shares in the expectation of making capital gains and ignored
dividends.
That's because, when a company is growing fast, share holders don't want it
to pay out money that could be used for reinvestment. Instead of receiving
income, shareholders want their companies to build another 10 stores or make
a takeover. They believe such activities will boost earnings and push up the
share price.
What generally happens, however, is that companies cannot grow at the same
pace forever and start making dumb investment decisions that destroy
shareholder wealth, pushing down their share price. When prices go down and
stay down, dividends become all-important.
The US gives a long term perspective. Following the stock market crash of
1929 dividend investing would remain in favour until the 1960s. Throughout
this period investors bought shares almost solely because of their
dividends. Since shares were considered to be a riskier class of investment,
they offered investors higher returns. Most of those returns came through
dividends. Investors wanted actual cash - not a future promise of higher
earnings down the road.
In New Zealand too dividends were regarded of utmost importance, and many of
our old economy companies were capable of paying them. But in the 1980s
rush, dividend investing went out the door in favour of rapid capital gain
(and subsequent loss).
In general, however, the New Zealand market has always delivered very good
dividend yields, more than twice that available from US shares. The fact
that our dividends are largely tax free, whereas dividends are taxed in the
US and elsewhere, has been a big incentive to local companies to pay good
dividends, and investors to expect them.
Choosing dividend yielding shares is not just a matter of finding the
highest yielding companies, however. It is better to give up some yield in
return for earnings reliability. But just as important, the dividend
yielding portfolio must be properly diversified, covering most industries. A
portfolio based just on highest yields could land you in only one industry,
such as property trusts or ports, which may just happen to be delivering the
best yields. A portfolio exposed just to one sector would be looking for
trouble.
The usual rules of diversification apply, where you do not want a portfolio
that is very vulnerable to a single event, such as a rise of interest rates.
A good spread of safe, high yielding shares might include property trusts,
energy stocks, banks and insurance companies and infrastructure assets.
The New Zealand share market might be small, but because this country was
among the first to move to privatise state assets, we have many strong,
dividend yielding companies to choose from.
The bottom line with a yield portfolio is that you cannot afford a
catastrophic failure of one of your shares, such as a company going bust.
That would destroy your returns in what is supposed to be a low risk
portfolio.
Because of that requirement, most of the shares in your yield portfolio
should have relatively low debt and excellent cash flow combined with a very
strong competitive position.