Why you should own shares? Dividends!

History shows us that shares are the fastest way to grow your wealth and increase your investment income.

For the last hundred and more years, shares have outperformed all other asset classes. This is because business continues to make profits through all of the drama history throws at us.  There is always some good reason why not to invest, but those who take a long term view will benefit for the returns of investing in shares.

At time markets will be trading above fair value at unreasonable prices while at other time trading well below their fair value. Over time these boom and bust events will pass, leaving the sensible investor with a healthy profit.  

But what are you buying when you buy shares?

In affect you are buying income; businesses are run to make a profit, business sell shares to raise money, much like borrowing from a bank. As such the owner of the shares is entitled to share in the profits and capital growth of the business.  

Why is income important?

A healthy business is making a healthy profit. This profit is shared with shareholders via dividends. As profits increase so too will the dividends, increase in dividends means an increase in the share price. But be warned if you focus too much on share price you will usually get it wrong.

Let’s look at an example:

If you had purchased Woolworths back in 1993 for $3.19, by the end of 2015 financial year you would have been paid $47.05 in dividends. This is more than 14 times what you paid for the shares. The dividends started at $0.40 per share and have grown to $4.63 per share as the company has grown its profits over the years. This is a healthy yearly return on your initial investment of $3.19.

At the same time the share price has increased from $3.19 to $22.93 a return over 600% on your initial capital invested or 25% per year.  As income of the company grows so too will the share price. Notethat the growth in the share price is not as smooth as the growth of the dividend.

This is because, shares are not always valued at fair value, the latest boom or bust news will affect the share price in the short term.  The key take away is that the share price is always secondary to the income stream the shares produce. Shares will at time be overvalued or undervalued as long as the income grows the price will return to fair value.

The main point is this; a rising dividend drags the price along with it. If you focus relentlessly on the income the company’s shares can produce for you, your result will be right in the end.