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28/08/20183 mins

The importance of income

One advantage of contrarian investing is that the out-of-favour stocks we look for often offer higher-than-average dividend yields. But we never consider a high yield an attraction in its own right.

All that glitters is not gold – and an enticing dividend is worth little if it can’t be sustained. That’s why we look for companies with a yield that is both attractive and sustainable over the long-term. As part of a ‘belt and braces’ approach we often look for a reliable dividend to provide us with a return while we wait for our investment thesis to play out. As we typically invest in companies where major change is planned or already afoot, this can be crucial. Executing an effective turnaround can require time and patience and we want to be sure that the company has the wherewithal to maintain shareholder payouts through potentially turbulent times.

Being paid for our patience

If our research shows that the dividend is sustainable, then we can afford to be patient – secure in the knowledge that we are being paid to wait. That’s an ideal situation for us: a strong dividend yield that gives us a consistent and attractive level of income while we await the return of health to the business – and hence its share price.

We value dividends not only because they boost portfolio returns, but also because we understand the importance of regular income to our investors.

Making income more predictable

We announced a step-change increase in our dividend in December 2017. This boosted the regular dividend by 48%, the total dividend increased by 11%. As our investment style tends to generate an above-average dividend income, compared with global equities, we have rewarded our shareholders with a higher and more predictable income stream than previously. Also, we have moved from semi-annual to quarterly dividend payments. This provides a more regular income to our shareholders. Of course, it should be remembered that dividend income is not guaranteed and can go down as well as up.

Thirty-four not out

Another key objective is to achieve dividend growth ahead of UK inflation. We have increased our net dividend in each of the last 34 years and the net dividend has been increased or maintained since at least the Second World War. Just as with our portfolio of investments, the sustainability of our own dividend is important to us and this is helped by revenue reserves of more than three times the regular dividend. This provides a strong foundation, so were the portfolio to experience a temporary shortfall in income the company would still be able to maintain its dividend policy.

Drip, drip

Finally, it is always worth emphasising the potential impact of reinvesting dividends. Dividends form a large part of total returns and this is especially true when the income is reinvested. Certificated shareholders can take advantage of our Dividend Reinvestment Programme (DRIP), allowing them to harness the power of compounding and potentially enhance returns significantly over the long-term. As at the end of July 2018, an investment in The Scottish Investment Trust would have returned 3 times its value over the last 20 years. With dividends reinvested, this would have increased to 3.7 times the original investment – an uplift of 25%. This underscores the importance of income – and shows how a steady drip of dividends can swell to a sizeable flow.

 

Please remember that past performance may not be repeated and is not a guide for future performance. The value of shares and the income from them can go down as well as up as a result of market and currency fluctuations. You may not get back the amount you invest.

The Scottish Investment Trust PLC has a long-term policy of borrowing money to invest in equities in the expectation that this will improve returns for shareholders. However, should markets fall these borrowings would magnify any losses on these investments. This may mean you get back nothing at all.

Subscribe to our newsletter

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