The past week has seen Vodafone PLC trade at a 7% dividend yield. For every £1.83 share you purchase, you get £0.14 in annual income. Put another way, if you buy £1,830 worth of shares, your annual income is expected to be £140. Although the dividend is expected to to rise in the next year, let’s assume that the annual dividend income remains at last years level of £0.15 (in the interest of conservatism).
Provided the dividend remains steady, each share of Vodafone purchased today stands to collect £0.28 in total, cumulative dividends over the next two years. Why is that important from a principal protection standpoint? Because it only takes a few years of collecting solidly high dividends to severely mitigate the risk that falling stock prices can have in making you feel as if you are moving backwards.
Here is an example of what I mean.
Say you bought 100 shares in Vodafone two years ago when it was was trading close to the £2.10. When you look at your investment account, you will see that you are approximately £28 down. But that price you see on you account doesn’t take into account the dividends you have received during this period. During this period, you would have received £28.17 in dividend meaning that your overall performance would be slightly positive. And with the impending dividend of £9 you are expected to receive in August, your investment will be in the black.
I mention this because, once you start collecting five or six years worth of dividends on a stock, the risk of losing money in a disaster scenario becomes severely mitigated.
Looking purely at the stock price does not give you a full picture about a stocks performance. You need to view the total return you are receiving. And dividend, especially in the UK market, play a big role in that total return equation.
A lot of times, people avoid stocks because they can be volatile. But if you can find excellent businesses giving you a steady stream of income, it can certainly cushion that volatility. It only takes a couple of years of dividend payouts to insulate you from the worst case scenarios. A lumbering 6% yielder, or a 4% yielder with a high dividend growth rate, will produce a good amount of income that could very well make you net profitable during the low prices of a recession that hits four or five years later.
Let’s say you were to own 100 shares in Vodafone at today’s price of £1.83. And let’s make another assumption that the company keeps its dividend steady at £0.14 a share – again this is being conservative as Vodafone has a history of increasing its dividend.
After your first year of ownership, you would have collected £140 in dividends. After the second yer, £280. The third year, £420. The fourth year, 560. The fifth year, £700. In five years, you would have collected dividends equating to close to 40% of your purchase price.
Over the five year period, Vodafone’s share price would have to drop by 40% or go all the way down to £1.10 for you to break even. In this instance, the dividends Vodafone pays out certainly cushions any downside risk. Isn’t that a sweet deal?
When it comes to sustainable high yielding shares, time plus dividends can overcome a lot of worst case scenario situations. At least, it’s something to keep in mind as you evaluate volatility in the context of your stock market investments.