Dividends provide investors with a secondary source of income and are an important component of long-term stock market returns. With that backdrop, it?s not hard to imagine why investors wouldn?t consider a share?s dividend yield as an important deciding factor when making an investing decision.
But, people invest primarily to grow their capital and purchasing power in the future. On that front, it?s important to see why it might not be ideal for an investor to forsake growth shares – shares of companies that are growing their businesses and profits…
Dividends provide investors with a secondary source of income and are an important component of long-term stock market returns. With that backdrop, it’s not hard to imagine why investors wouldn’t consider a share’s dividend yield as an important deciding factor when making an investing decision.
But, people invest primarily to grow their capital and purchasing power in the future. On that front, it’s important to see why it might not be ideal for an investor to forsake growth shares – shares of companies that are growing their businesses and profits quickly – completely. Let’s consider the following four shares as an example.
The first two shares are telecommunication operators Starhub (SGX: CC3) and SingTel (SGX: Z74). Both companies have had anaemic earnings growth of 3.7% and 0.4% per year respectively over their past five completed financial years.
But, they pay out a huge portion of their earnings as dividends, and so, are able to reward shareholders with a high dividend yield. Starhub’s currently yielding 4.8% while SingTel’s at 4.6%.
The next two shares are instant beverage manufacturer Super Group (SGX: S10) and healthcare services provider Raffles Medical Group (SGX: R01). Both companies have low dividend yields of 1.6% and 1.4% respectively, but can be considered as growth shares due to their fast-growing earnings.
Over their last five completed financial years, Super Group’s profits have logged an annual growth rate of 33.2% while RMG’s earnings increased by 15.9% per year.
If you’re an investor focused on yield, you’ll likely forsake Super Group and RMG for Starhub and Singtel, given the much higher yields of the latter-pair. That’s fair, if income generation in the short-term is of higher importance.
But here’s where you might be doing yourself a disservice if Super Group and Raffles Medical Group were dismissed because of their low yields.
Over the past two-and-a-half years, from the start of 2010 to 8 July 2013, Starhub and SingTel’s total returns – the sum of capital appreciation and dividend distributions – stand at 127% and 39% respectively. In comparison, the Straits Times Index (SGX: ^STI) appreciated by only 9% over the same time period, so both telcos had comprehensively beaten the market.
But, the telcos’ level of outperformance was overshadowed by Super Group and RMG’s total returns of 658% and 132% respectively.
Despite the much stronger income-proposition that the latter pair represented on Jan 2010 – at that time, Starhub and Singtel had trailing dividend yields of 9.8% and 4.7% respectively, as compared to Super Group and RMG’s yields of 2.7% and 1.9% – it was the growth-pair that outperformed the market the most as their shares grew in price to reflect their underlying earnings growth.
Foolish Bottom Line
While it’s important to consider the dividend yield of a share when making an investing decision, it might be even more important for investors to think about its expected total return. Otherwise, they might be doing themselves a disservice by unduly dismissing growth shares on the basis of a low dividend yield when it might be the one that holds the better promise of superior total returns.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing owns shares in Super Group.