Last Sunday I received a telephone call that no one wants to get. Miss Barefoot had been in a car accident. The story goes that while Mad Maxine was navigating the rocky terrain of the supermarket car park, a mean-spirited pole – with trouble on its mind – jumped out and struck the front fender of our 18-year-old Toyota Corolla. This rendered the nose of the beloved red rocket permanently incapacitated.

With impeccable timing that only occurs in the movies, her mother rang moments later. Awkward chit-chat with the mother-in-law is customary, so when she enquired how her darling was I innocently replied, ‘well that depends…before or after the car accident?’

Hindsight is 20/20

Now with the benefit of hindsight I understand this was not one of my better lines. Obviously her daughter is a prized asset that’s best not made light of, and predictably she became quite agitated. ‘Sell that damned car,’ she snapped. ‘It’s nothing but trouble’.

I pointed out that a good tradesperson never blames their tools, and as such I was quite sure that Toyota could not be held responsible for a wayward pole, but she was resolute – the car had to go.

Emotional times

Making decisions that are clouded by emotion almost always leads to an irrational outcome. Lately I’ve been receiving emails from people using much the same logic about their prized assets and the ‘share market crash’ we (apparently) had.

‘Share market wipes out all of this years gains’ screamed one headline. ‘Investors lose billions’ wailed another. While I would argue that the crash was more like a fender scrape in a supermarket car park, the emails kept coming. They were mostly motivated by fear (should I sell?) or greed (what stocks are bargains?).

‘Buy on the dips’ goes the old chestnut. Unfortunately, although it sounds good in theory, this sage advice does little to soothe the soul of a soon to be retiree reading sensationalist stories.

So I went looking for evidence to back this credo. Just how low were the lows in the stock market over the past 12 months?

How much movement has there been, allowing prudent investors to pick up stock relatively cheaply and reap the rewards fairly quickly?

I gathered the 52-week highs and lows for some of the biggest and most widely held companies on the stock exchange. This highlighted just how well most of the companies had done over the past 12 months, and put the ‘correction’ in perspective.

One of the biggest advantages of investing in shares is liquidity – the ability to buy and sell throughout the day, every day.

Unfortunately to the uninitiated this is also sometimes incorrectly perceived as a disadvantage, due to the fluctuations that occur as a result of millions of people making snap decisions to buy and sell – usually emotional decisions driven by greed and fear.

Seeing is believing

A company’s share price is often the most visible tool that investors use to rationalise a buying or selling decision but it’s only one yardstick. It’s also difficult to predict over the short term, despite what the technical tea-leaf traders will tell you.

It’s more important to have a good understanding of a company’s profits now and in the future. These profits can be retained by the company to fund future growth and/or paid out to share holders in the form of dividends.

Stay with me here.

In its crudest form (which will have share analysts tearing their hair out), a company’s value is the total number of shares on issue multiplied by the current share price. If a company were to retain some or all of its earnings, the value of the company would rise to take into account the increased cash reserves. Whilst the share price of the company may well bear no correlation to this ‘increasing value’ over the short-term, it’s a different story in the long term.

But the trouble is, in the long-term we’re all dead.

Paper profits

You can’t eat paper profits, and selling some of your shareholdings to generate income to eat involves paying commissions and incurring capital gains tax. So let’s look at the other side of the equation – a regular injection of cash in your pocket from your share holdings.

Dividends, rather than share prices, are infinitely easier to predict. Most companies, managed as they are by well-paid executives (often with performance-based options as incentives) are loath to cut their dividends lest they be slapped by the super-nanny that is the share market. Share analysts, just like the disciplined diva, find this unacceptable behaviour that is often corrected by sending the share price south to sit in the sin bin.

Prime example

Let’s take Woolworth’s as an example, which I have shares in. The company floated in 1993 at a price of $2.45 per share and paid a final dividend of 6 cents per share that year. Since floating the company has paid out $4.10 in dividends, which means that shareholders who invested in the float and rode the market’s bumps have had their initial investment paid off from their dividends. As a result of this, the company’s share price is currently $27.35 – some 1016% from the float price 14 years ago.

Investing in companies that have growing dividends offers two advantages to investors. Firstly, each year income increases (usually at a higher rate than inflation), and secondly a strong ongoing dividend helps to weather the storm when inevitably the share market hits some turbulence.

I personally weathered my own storm this week, managing to avert the emotional knee-jerk reaction to sell my prized red rocket. After all, why would I want to sell something that had been a consistent, reliable performer over the years, only to have to replace it with a costlier version? Instead we managed to refit a shiny new bumper on the beast for the princely sum of $100. Now everyone’s happy. I think.

Tread your own path!