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Why Inflation-Beating Income is Important for You

Money tree 2

Inflation is an insidious silent killer of our wealth. We might have a million dollars today – I don’t, but I hope you do – but come 20 to 30 years later, that million dollars would purchase far lesser than what it could now.

Dividends from shares give us a secondary source of income apart from what we get from our day jobs. So naturally, dividends are important to us, as investors. But what most don’t realise is how inflation can chip away at the purchasing power of those dividends if they remain constant.

I’ll illustrate why.

What’s bad about constant dividends?

Suppose you’ve found a share giving a 7% dividend yield, say construction and chemical products manufacturer NSL Limited (SGX: N02), and invested $1,000 in it. We’ll put any questions about the sustainability of NSL’s dividends aside and assume it will continue paying out $0.10 per share in annual dividends for the next 10 years as it has done so since 2009.

With an investment of $1,000 and a dividend yield of 7%, we can expect $70 in dividends coming from NSL every year. That’s a steady income stream which should be good for us, right? Not so fast.

With the assumption – a reasonable assumption, I would add – that inflation would run at 3% per year for the next 10 years, the $70 dividend-check coming in at the 10th year would only be able to purchase $46 worth of goods at today’s prices!

That’s why we need to protect our dividends’ purchasing power by ideally having shares that can grow their dividends above the rate of inflation. With inflation-beating growth, those dividends coming from shares can enable us to purchase even more than we could today.

Some inflation-busters!

From 2003 to 2012, inflation has run at an average rate of 2.8% per year, according to data compiled from The Singapore Department of Statistics.

The following three shares are just some examples of companies that have been growing their dividends at inflation-beating rates over the past 10 years from 2003-2012.

Compounded Annual Growth Rate for Dividends from 2003-2012
Jardine Matheson Holdings (SGX: J36) 16.9%
Jardine Strategic Holdings (SGX: J37) 5.8%
Vicom (SGX: V01) 12.5%

JMH and JSH both belong to the sprawling conglomerate, Jardine Matheson Group. JMH, as its name suggests, is a holding company with interests in engineering and construction, transport services, restaurants, IT services, motor vehicle sales and insurance, among many others.

JMH also owns 82% of JSH. Dividends for JMH have grown every year from US$0.3 per share in 2003 to US$1.35 in 2012. It currently sells for US$60.04, giving its shares a trailing Price-Earnings (PE) ratio and dividend yield of 13 and 2.2% respectively.

JSH is also another holding company with substantial interests in other locally listed shares like property group Hongkong Land and retailer Dairy Farm Holdings. Interestingly, JSH is also owner of 55% of JMH’s shares, making the cross-links between those two holding companies very complex.

Dividends from JSH started at US$0.145 per share in 2003 and have since increased to US$0.24 in 2012. Shares of the company, currently worth US$37.32 a pop, are selling for 12.5 times historical earnings and yielding 0.6% based on trailing dividends.

Moving on to Vicom, its dividends have jumped from S$0.063 per share in 2003 to S$0.182 in 2012. The company inspects vehicles and provides testing and inspection services for industries that deal with construction, food and chemicals, among others, for a living.

Vicom’s shares are exchanging hands at a price of S$4.75 apiece, carrying a PE ratio of 15.6 and sporting a trailing dividend yield of 3.8%.

Foolish Bottom Line

Shares with steady, unchanged dividends can be a good deal, especially if investors can invest in those shares at very high dividend yields. But, it is also pays for investors to note how inflation can be slowly-but-surely choking away the purchasing power of those dividend-incomes and how they can protect that income from inflation’s ravages by considering dividend growth as well.

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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 doesn’t own shares in any companies mentioned.