Income strategies for different investors
- Fri 06 November 2020
Three Canaccord Genuity advisers examine income investing from different angles: Jacqui Mengler-Mohr (pictured) explains a strategy for risk-tolerant investors; James Blaufelder discusses the power of dividend reinvestment; and Kay Lee outlines a strategy for conservative retirees.
Jacqui Mengler-Mohr, Canaccord
In January 2020, the traditional attachment to “blue chip” shares in Australia was at an all-time high with investors seeking yield. No matter what negative news story hit, the blinkers were on and dividend yield was the driving force behind share-price support. Then COVID-19 happened.
We now have an unprecedented global pandemic that is rocking our everyday lives in ways unimaginable at the start of this year.
Consequently, financial markets in Australia and around the world have endured a significant shake-up. This has led to many investors scratching their heads about where to invest for yield when the traditional haven of the banks and other top 20 and top 50 ASX stocks have seen more than half of these companies cutting their dividend in the recent August reporting season.
This year is hugely different, with only 36% of companies reporting rising earnings compared to the normal 66%. Financial stocks have been hit the hardest, with more than 30% of companies reporting a reduction in their earnings. This hit to earnings has made it challenging for investors who have traditionally relied on banks and financial stocks to provide a high dividend income to investors.
But some investors recognised the change for what it is – an opportunity to achieve the same goals using different strategies.
The question is, where to invest? The answer is where the earnings are because that is where the dividends and capital growth traditionally follow. Suddenly, resources and mid-cap stocks were being talked about as yield stocks and more traditional ‘blue chip’ income stocks were somewhat on the sidelines as the share price and dividend action happened outside the traditional high dividend-yielding stocks.
Border closures and lockdown living immediately spawned a change in consumer habits that saw retail stocks that were agile using their established online presence as accelerators for revenue growth. These companies have rewarded customers with deliveries when they are stuck in lockdown and investors with soaring share prices and healthy dividends.
Similarly, strong commodity prices and demand from China, particularly for iron ore, have seen some resource companies pay out record dividends in a year when many long-term dividend expectations have been slashed.
Only one year ago, an investor might ask “why would I invest in resources or mid-caps for income?” Now they are asking themselves, “why not?”
Yes, it is not the traditional strategy for creating income and yes, there may be different [and potential higher] risks attached. But then the risks associated in a normal trip to the supermarket have changed, too. Attractive income investment opportunities exist in ASX resources and mid-cap stocks for agile and adaptable investors.
James Blaufelder, Canaccord
The sharemarket is a powerful tool in creating wealth, but you have to know what you are doing. Creating wealth over the long-term is no doubt why a lot us turn to shares because, if done correctly, investing a small amount each month over a 30-year period can yield substantial returns.
Yes – I am referring to compound interest through reinvesting dividends.
Warren Buffet declared that the single most powerful factor behind his investing success is compound interest. The Oracle of Omaha became a billionaire at age 56, which is considered quite late by today’s standards. Not because he invented a new product or created a tech company, but because he was hyper-disciplined in reinvesting investment returns that he had made over the preceding 30-year period.
In the current low-interest environment, growing wealth has never been harder - without having to take more risk. With interest rates likely to remain at record low levels for the foreseeable future, the sharemarket is one of the few alternatives investors can use to grow wealth.
Dividend reinvestment uses the cash dividend paid by a company to buy more shares of that same company. Most ASX-listed dividend-paying companies allow the shareholder to nominate a dividend reinvestment plan (DRP) when you purchase the shares. You will find most ASX listed companies that offer a DRP also provide a discount to the current share price when reinvesting your dividend – so you get more shares!
Here’s an example of how dividend reinvesting works. An investor owns 100 shares in XYZ Ltd which pays an annual dividend of $5.00 per share. Thus, the shareholder receives $500 in dividends. If the shareholder has opted to reinvest their dividend, the $500 will go back into buying more shares in XYZ. If the share price of XYZ is trading at $100 the shareholder receives 5 new shares bringing the total amount to 105 shares.
The following year, the same process is repeated, and the investor receives $525 in dividends. XYZ is trading at $105 per share, so the shareholders’ reinvested dividend would boost their total shareholding to 110 shares. This compounding effect over a 30–40 year period can return impressive results in the accumulation of wealth.
Source: Canaccord Genuity
The pros of dividend reinvesting include dollar-cost averaging, no brokerage fees, the benefit of compounding growth, a potential purchase discount and a good long-term savings strategy.
However, there are some cons, which investors should consider. These include no control of the purchase price, reduced diversification, and a strategy not suitable for investors with a short-term timeframe and no income stream.
In conclusion, dividend reinvestment can be an attractive option for investors looking to maximise capital growth through a portfolio over the medium to long-term.
Kay Lee, Canaccord
My Aunty and I were exchanging recipes for mooncakes akin to the dumpling scene in the movie Crazy Rich Asians. We were preparing for the Mid-Autumn Festival and decided to make the Cantonese version which has a filling of almonds, walnuts, peanuts, sesame seeds and melon seeds. The ingredients represent the values of benevolence, righteousness, courtesy, wisdom and trust.
Naturally, our conversation meandered to her share portfolio and the investment themes that I would implement for generating income for her.
The exceptionally low interest rate environment has forced retirees to take on measured risk to generate income from their capital which would normally be in a term deposit. Which sectors would meet these requirements?
Agribusiness is an obvious sector as Australia has a clean and green reputation. Our farmers are constantly innovating to produce high quality and high margin food because they need to overcome the negative effects of drought and bush fires. Major fresh food retailers have also benefited from the efficient supply chain, providing steady dividends over the long term.
As the economy slowly returns to pre-coronavirus conditions, infrastructure companies will resume their growth trajectory as more people return to work and use toll roads and other utilities. These companies have always been part of a defensive portfolio and the essential services they provide will be the foundation for a constant stream of dividends.
The resource sector has been one of the few shining lights during these volatile months. The major mining companies have maintained or even grown their dividends, which makes them outliers compared to many industrial companies which have reduced their payments to shareholders.
Despite the majority of ASX 200 companies suffering profit downgrades and cuts in their earnings at the last reporting season, for many resource sector companies it has been business as usual.
Specifically, for gold companies the uncertainty around the global pandemic has actually increased demand for the precious metal and ratcheted the price up for the major miners.
Although the banks have been forgotten in the rush for investors to pile into the not yet profitable fintechs, I belive there is value in bank hybrids, which are paying a fully franked margin above the bank bill rates.
These subtle shifts in her portfolio prompted my Aunty to thank me for planning to maintain her retirement lifestyle.
Note: The above advisers – and many others – can be found via ASX’s Find an Adviser page. Search for one that suits your needs today.
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About the author
ASX acknowledges the Traditional Owners of Country throughout Australia. We pay our respects to Elders past and present.
Artwork by: Lee Anne Hall, My Country, My People
