One of the most common requests for a Screening for Value article is for an income screen. It is not a surprise that income strategies are some of the most popular amongst value investors. The idea is that, by investing in companies that pay above-average dividends, investors can capture both the value premium from owning cheaply-rated stocks and generate a higher-than-average income.
Weak markets can make for difficult investment decisions, but the flip side is that some exceptional yields are now on offer from UK stocks. Of course, some companies may cut their dividends, but dividend payments are often surprisingly robust. One of the arguments that economist Robert Schiller makes for stock markets not being fully efficient is that prices are far more volatile than the future dividend stream proves to be. In highly volatile markets, the surety of knowing that regular dividend payments are arriving to provide spending power or be reinvested into cheaply-valued stocks is a salve. Investors are likely to have felt the soothing power of dividend income this year.
While higher inflation and political uncertainty haven’t provided the best investing backdrop, the current challenges are very different to where investors found themselves in March 2020. Back then, the level of uncertainty meant that companies were cutting dividend payments completely. In contrast, today, many companies are increasing their dividends and adding share buybacks as well. Despite this, valuations remain low, meaning that the yields on offer look highly attractive. So now could be the ideal time to invest for income. But do income investment strategies outperform?
Before looking at the data, it is worth dispelling a couple of income investing myths that crop up from time to time.
Myth 1 – Reinvested dividends make up the bulk of stock market returns.
This myth usually comes from studies comparing the market returns with and without reinvested dividends. For example, the 2017 Barclays Equity Gilt Study says:
One hundred pounds invested in equities at the end of worth just £195 in real terms without the reinvestment of dividend income. With reinvestment, the portfolio would have grown to £32,050.
Of course, these are not comparing like-with-like. If an investor didn’t reinvest these dividends, they would have had the cash to spend or invest in other assets. In fact, if another asset class produced superior long-term returns to equities and dividends were reinvested there, then the total return would exceed that…
