Here’s a thought
Imagine a scenario in which you buy a share knowing that you will not be able to sell it. Ever. Instead, the purchase must be justified solely on the basis of the dividends that the share will provide for as long as the company remains in business. When your time is up, you will pass the share on to your descendants. Let’s assume you are fond of your descendants and keen for them to do well.
In this sort of world, how would you think about choosing which shares to own ? Obviously you wouldn’t give much thought to what the share market might do – it will have no bearing on the outcome. The things you would be interested in are: the capacity for the company to pay dividends over the long term; the potential for the dividend to grow or decline, and the risk of the company going out of business.
This would be a challenging world in many respects, but a very comfortable one in some ways. For one thing, having made your investment decisions, you would not be concerned about the possibility of a stock market crash – share price gyrations simply won’t affect you.
For another thing, you would have extra time on your hands, not needing to worry about whether it’s time to rotate from one sector to another to take advantage of changing fortunes.
Perhaps more importantly, if you invest well you will stand an excellent chance of getting good investment returns. Not having to incur any brokerage or other transaction costs and never paying any CGT would help boost your returns, and if some of your holdings do well over the long term, their profits and dividends could multiply many times over. The full magic of compound returns could be brought to bear for the benefit of you (and of course those lucky descendants).
Evaluating each investment you make as though you will need to own it forever can add an interesting perspective to the decision. If the stock is not a keeper, then is it really good enough to go into your portfolio ?
Happily, if you invest this way you still retain the option to sell, should circumstances change down the track. Or if your descendants do something that really annoys you.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
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Raymond Lundie
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Interesting argument, when Adam played full back for Jerusalem I bought 4 Stocks; a cash cow called CUB became Fosters, BHP, ANZ, initial Mirvac float. Roger says the boat is more important than who is rowing it, though sometimes the rower is looking at the past and not the future where the rocks are.
All of the above have been guilty of this and without dividends I doubt whether the shares price would be higher than they are today.
Chris B
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I would be looking more at how stable the company will be in 20 years. I wouldn’t invest in a technology company since it is very hard to know where it will be in 20 years. Look at Nokia, Amstrad, Commodore……
Competitive advantage and moat are very important.
The funny thing about dividends is that the people who make the most dividends are the people who don’t think about the dividend yield. If you have a company paying a dividend of 3% with good growth and another company paying a dividend of 7% with no growth, the company paying a 3% dividend will pay you far more over 20 years.
Roger Montgomery
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Spot on Chris. Go back to the first or second White Board Series video in the video section here. I explain the maths by comparing Telstra to M2.
Lloyd Evans
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Interesting article and akin to Buffet’s thoughts on the market “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years”.
Buying a business based on a dividend stream does not fit my investment thesis.
Instead of the business paying me the dividend, which I then would have to deploy at a substandard rate of return (say in cash), I would prefer a superior business, retain this capital and reinvest it within the business at high rates of return on equity.
The other issue I have is that although CPI is running at 2.4%, the actual cost of living for me is significantly higher, and as such the purchasing power of a term deposit yielding 3-4% is negative.
Michael Horn
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In concept, that style of investing is what I aim to do – that is, envisage the long-term dividend stream. However, guesstimating dividends for the long term is extremely subjective, and one will never get it right – there are too many unknowns.
paulysav
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That is a great mindset to have when purchasing stocks and a way that I have explained to clients for a while. It helps them with the emotional side of investing and I always bring it up again when they get jittery about some external factor.
Andrew Legget
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Interesting post Tim, i quite like these ones where it is more a metaphor to help look internally and work out what you believe.
I agree with the concept of “buying companies that you can hold forever”. There is no doubt that these companies definitley exist (Coca Cola (KO) being an obvious one). My worry is whether there are many in Australia that fits this mould.
It is interesting you mention dividends (it makes complete sense as you can’t see so capital gains don’t exist). I would love to have the time and ability to test my hypothesis but i feel that the domination of superannuation funds on the market and their desire for income might actually be leading to few companies that fit the “hold forever” type crowd.
Australia has a love affair with dividends, i would love to see stats on it but i would imagine that companies in Australia see their pay out ratio tick up faster than in other countries. Sure we have a samll population compared to other countries so maturity can come quicker but i don’t think this would explain everything.
The question i am posing is whether the desire for income by the marginal investors who control a lot of the invested funds is acting as an incentive for companies to focus on paying dividends instead of reinvesting in other areas that could see businesses become much stronger companies (R&D, innovation, growth)?
As i said, i would love to be able to test that theory out. It makes sense that when the market is made up a lot of people who want yield that companies will be driven (due to the significant holdings by these companies) to focus on that and that is stopping companies from being like an Apple (or BRK) where instead of being paid out the funds are being re-invested to make the company stronger and there for allowing it to become more of a buy and hold forever company.
So that leaves the companies which have a global footprint already (Cochlear, CSL) as ones that have the potential to be these companies, others such as WOW and CBA will grow with the population so they fall in there as well. However, are some of the other companies taking the easy way out?
I guess and this is my final thought, that there is not much being done by in Australia to help encourage development of ideas-based entrepreneurs who could develop products that have a world-wide audience (ignoring COH). Instead we focus almost exclusively on mining, manufacturing, agriculture, finance and retail (but not the design).
Anyway that is my thought for the day.