Equity income investing is also supported by historical evidence that suggests dividends account for a large share of total returns. Consistent dividend-payers and growers also tend to be excellent stock market performers over time. All in all, this makes investing for equity income a compelling proposition in today’s market environment.
Why now for equity income?
Dividends become even more important in uncertain times. In tough economic market conditions, investors can make their savings more defensive by favouring those companies with stable earnings that have a proven ability to produce good results regardless of the ups and downs of the economic cycle.
Companies whose earnings are reliable and who have a consistent record of paying out and growing dividends become particularly attractive. Investing in such companies not only gives investors the comfort of an attractive income stream in an otherwise low-yield environment, the dividend payouts also provide a cushion against possible price declines.
Can dividends be maintained?
Detailed research is required to ascertain which stocks can sustain and grow their dividends. During the recent financial crisis, earnings dropped sharply and dividend payments were no longer sustainable for many companies. This was very much the case for European and US banks. At first, the share prices of these banks fell sharply and, for a while, they appeared to have very attractive dividend yields. But any investor buying into this false signal would have been sorely disappointed because the dividends of many banks were subsequently scrapped.
The key is to select high-yielding companies whose financial condition is strong and who are likely to keep paying their dividends. Even more valuable are those companies which not only continue to pay but also grow their dividend payments.
ISA investments in 2011 were very focused on income, reflecting the continued poor returns available on cash deposits. Dividend investing strategies tend to have defensive qualities that are well suited to the current challenging environment. The fact that many of these proven dividend-payers are high-quality, blue chips with strong balance sheets and high cash flows is attractive.
Moreover, total returns can be hugely enhanced if dividends are re-invested. History shows that over the long run, it is actually the compound growth of reinvested dividends that delivers the majority of total returns. In short, equity income plus patience is a fantastic growth strategy.
Tom Stevenson is investment director at Fidelity Worldwide Investments. The views expressed here are his own.