Cash flow is King

For those reliant on investment income to meet their needs, the last few years have been harrowing.  Watching the value of your investments fall can create concern about your ability to fund your future needs.  However, when we look at the income provided by a diverse investment portfolio, we have actually seen income increase over the past couple of years.  This is the result of higher interest rates and increases in share dividends.  
Some might question the wisdom of investing in shares right now – with the papers and media full of conflicting reports and opinions.  However when you consider the longer term picture, the cash flow reward for investing in equities, over an investment in term deposits, is even more pronounced today.
For example, an investment in QBE 15 years ago would have provided a dividend of $0.26 per share for the year.  Holding that same investment 15 years later sees a dividend of $1.28 per share – an increase of 11.2% per annum.  The dividend today of $1.28 represents a return on the original investment of some 16.6%.  With that sort of return, you don’t need much growth in share values!  The same calculation can be done for most quality Australian companies, despite the significant fluctuations in their share prices over time.
Whereas the same investment in a term deposit will have seen no growth in the income paid…with current term deposit rates only around 5% to 6% per annum.
Investors need to remember that dividends paid by companies are not determined by their share prices, but by the profitability of the company.  Also companies do not pay out 100% of their profits as dividends.  Instead they pay out amounts of up to 80% of their profits as dividends, with the balance retained for reinvestment in the company.  Some, such as BHP pay less than around 26% of their profits as a dividend.  On that basis the retained profits increase the value of the company and such action should be reflected as a growing share price over the longer term.
Share prices will fluctuate daily based on the actions of buyers and sellers in the share market.  However as owners of great Australian companies, it’s evident that share holders who keep their investment will be rewarded over the longer term by increased cash flow from dividends.