The case for equity income investing

With authorities around the world seeking to alleviate the consequences of the credit ‘crunch’ for consumers and companies, the rates of income payable on most asset classes have changed significantly. In this environment, we have been reminded that a transparent and understandable income yield, allied to the prospect of longer-term capital growth, has appeal as a core component of a sensible investment strategy. Near-term changes in asset prices are uncertain, but in this article we consider the longer-term attractions of harnessing income from investing in equities.

The case for an income-focused approach to equity investing is essentially twofold:

• First, equity income (whether required or not) forms an essential component of an investor’s long-term total return.

• Secondly, by concentrating on income-bearing shares, investors benefit from a number of qualities that issuers of those shares tend to demonstrate. In addition, dividend yield can be used as an aid to timing purchases (when the yield on a stock rises and the price falls)and sales (when the yield on a stock falls and the price rises).

By investing over the long term in income-generating equities, investors can enjoy real growth in income together with long-term capital growth. A focus upon companies that pay a regular cash dividend leads investors to hold a portfolio that is comprised of companies that are reasonably valued, that generate cash flow in a sustainable manner, that are sensibly managed and financed and that allocate shareholders’ funds with a view to longterm returns on capital.

A dividend is much more than merely a component of the overall return from a stock. It is tangible evidence of a firm’s profitability and represents a commitment by the management of a company to return the cash flow it generates to shareholders on a regular basis.

In addition, the regular payment of a dividend:

• aligns the interests of a company’s management with those of its shareholders (assuming management is paid in restricted stock rather than options – see below), with compensation being linked to shareholder returns rather than to stock options that do not give holders a right to a dividend

• makes it less likely that cash will remain idle on a company’s balance sheet

• reduces the likelihood or incentive of management to burden a business with too much debt