Growth through Dividends……

Dividends are the forgotten element of successful investing. Like the proverbial Aunt Sally, they are often derided as unimportant. Capital gains are much sexier, the stuff that creates the wealth of dreams. They of course enable investors to ride off into the sunset to enjoy their remaining years, or not, as the case may be.

And yet surely some cash in the hand has to carry some value? There are so many tales of the destruction of the share price by ambitious “highly incentivised” executives that a promise of jam tomorrow should be treated with a healthy degree of scepticism. Certainly equity income funds are quite popular in some quarters at present. However I leave it to my Enterprise Britain colleagues John Greengrass and Jon Levinson to comment on how dividends affect investor sentiment in the wider economy and markets.

My own focus is dividends in smaller, primarily owner managed, businesses. Even here there is an element of misunderstanding as to the real value of dividends. They are either dismissed in entrepreneurial circles as starving the business of investment cash or they are promoted by accountants as being a tax effective way to extract income from the business, always assuming that distributable profits are available to cover such income.

(A brief word of warning here. It is amazing how often businesses that pay regular dividends in lieu of salary forget this basic principal and end up paying them illegally. If you have been advised to take out regular dividends make sure you prepare some management accounts to ensure you are making enough post tax profit to justify your dividend.)

And yet regular dividend payments from sustainable business revenues are normally a good sign of a healthy business. A genuine dividend payment requires profits and cash. Old fashioned concepts I know, particularly in a world where business social networking site LinkedIn can be valued at 25times its sales revenues (that is sales not profits). However as a route to future growth and wealth they are concepts that are hard to beat.

I am certainly not advocating that dividends should be paid regardless of the cash needs of the business. However I do think that when businesses are planning for future growth, either for their existing owner managers, or to attract new investors, a little thought as to how much of the return will come from regular cash dividends could pay ..er.. dividends.