by Scott Pape - June 17th 2006
Republican Senator Everett McKinley Dirksen once remarked, “a billion here, a billion there, and pretty soon you’re talking about real money”.
He could have been talking about the share market, which this week suffered its biggest fall in five years. Some $25 billion was wiped out in just one day.
Falling financial markets never fail to hit the headlines, and this time was no exception.
Newspapers across the country heralded the horror with the usual tags; “Stocks pummelled”, and “Market in freefall”, among others.
These headlines and the news copy that follows are what I like to refer to as “financial porn”.
Most of what is written is at worst sensationalist, and at best pre-supposes that the reader has an economics degree and understands the implications of “Asian hedge funds fearing inflationary pressures in the US”.
What the?
Given that the Federal Government has legislated that our long-term superannuation savings be invested in financial markets it’s important to have a general understanding of what the newsreader is talking about when he spouts that “our market was stronger today in line with a rise in Wall Street overnight”.
The ASX
The most common benchmark used in the media is the ASX 200. This represents the 200 biggest companies listed on the Australian Stock Exchange by market capitalisation. It includes big name brand companies such as Telstra, the banks, BHP Billiton, Coles, Myer and Woolworths.
A rise in the ASX 200 reflects that these shares have generally had a positive day and their share prices rose. As we’ve seen this week, a fall in the index represents declining share prices.
Despite its universal appeal, the ASX 200 is a flawed benchmark for long-term investors because it focuses solely on the price movements of shares. This mistakenly classifies share market investments as purely growth assets.
Money matters
In reality there are two ways to make money from any financial asset; firstly an increase in the price (which is what most people focus on and try to predict), and secondly the income flow it generates.
In the share market this comes in the form of the share price and dividends paid from profits, while in property it comes from the value of the property and rent.
Peter Thornhill, author of the excellent book Motivated Money suggests that “all too often investors pay too much attention to share prices without fully understanding the value of dividends, which are the surest, most dependable way to wealth”.
Dividends
Not all 1700 companies that are listed on the ASX pay dividends however. Speculative mining companies, biotechnology and new technology companies are traditionally less likely to make profits or pay dividends.
To illustrate the difference this makes in overall returns, from December 1979 to 2004 an investment in a broad group of resource companies (such as BHP Billiton and Rio Tinto) with dividends reinvested would have seen your money rise 9.2 times over the period. Contrast this to an investment in industrial companies (manufacturers and service companies such as Woolworths and the banks) would have risen about 43.7 times over the same period!
The graph illustrates the power of accumulated dividends, and the reason why the preoccupation with the ASX 200 price index is only telling half the story for long-term investors. Essentially the only way you can “make a profit” from a growth stock which pays no dividends is by selling, which sets off transaction costs and tax implications.
In the short-term a company’s share price is dictated by market sentiment – whether the market is up or down, and what analysts perceive the future outlook is for the company. In the long-term, however, the company’s share price will generally be in line with the dividend returns that the company historically pays.
It’s for this reason that most serious long-term investors focus on the regular reliable (and in most cases rising) dividend payments for the bulk of their returns.
Successful investing
Day-to-day reading and following of the stock market is about as interesting as watching paint dry. Short-term movements of the stock market are now piped through to our living room, a byproduct of 24-hour cable news. In most situations, access to more information leads to better decision making. Yet with investments it tends to have the opposite effect.
Successful investing is about shutting out the day-to-day noise of financial folly and instead focusing on the gentle chirp of long-term dividend-paying companies.
For those people that have better things to do with their time than pore over financial reports, a great way to do this is by investing in a traditional listed investment company such as Argo Investments or the Australian Foundation Investment Company.
These companies operate in much the same way as managed funds; one investment gives you a diversified portfolio of shares, with a professional manager making the buying and selling decisions on your behalf.
Importantly, these companies offer excellent value for money, charging rock-bottom management fees that leave other less successful fund managers for dust.
AFIC has been around for 78 years. In that time the company has only once failed to pay a dividend (around the time of the Great Depression), and has a philosophy of delivering shareholders a “growing stream of dividends” in the future.
Perhaps the final point is to keep things in perspective.
The “mini-meltdown” that occurred this week was very well publicised.
Stocks are down about 8 per cent from their record highs, yet what the media reports fail to express is that they are up more than 80 per cent since mid-2003.
Tread Your Own Path!
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