INTRODUCTION: John D Rockefeller, widely considered the wealthiest American of all time, famously said: “Do you know the only thing that gives me pleasure? It is to see my dividends coming in.” Dividends are one way in which companies “share the wealth” generated from running the business. Dividends are usually cash payments to shareholders. Companies that pay dividends are usually more stable and established, not like companies still in the rapid growth phase of their life cycles. South African companies normally pay dividends once, and often twice, a year.

Dividend investing can be a great investment strategy. Research in the US has shown that dividend stocks have historically outperformed the S&P 500 with less volatility. That is because dividend stocks provide two sources of return: regular income from dividend payments and capital appreciation of the stock price. This total return, the combination of capital growth plus dividends, can add up over time. Because of their lower volatility, dividend stocks often appeal to investors looking for lower-risk investments, especially those in or nearing retirement. A diversified portfolio of dividend stocks can produce reliable income, come sunshine or rain.

DIVIDENDS AND EX-DIVIDEND: On the date when the dividend is paid, the company goes “ex-dividend” (ex-div). On the ex-div date, the stock price is adjusted downward by the amount of the dividend paid by the exchange on which the stock trades. In other words, when you receive a R100.00 dividend on your Anglo American shares, the share price of Anglos will likewise drop by approximately R100.00. For most dividends, this is usually not observed amid the up and down movements of a normal day’s trading. It becomes more apparent, however, on the ex-div dates for larger dividends, such as the R100.00 dividend in the example. The reason for the adjustment is that the amount paid out in dividends no longer belongs to the company, but to the shareholders. Benjamin Graham, American economist, professor, and investor, summed it up like this: “The stockholder wants both income and appreciation, but in general the more he gets of one the less he realizes of the other.”

IMPLICATIONS FOR INVESTORS: Dividends used to be tax free in South Africa. Dividends are paid by companies out of after tax profits. Taxing dividends amounts to double taxation. However, on 1 April 2012, government introduced a 15% tax on dividends received. This tax has increased to 20% in 2018. The dividend tax is a withholding tax – government first take its 20% share before the balance of 80% is paid to shareholders. The Dividend Withholding Tax (DWT) is payable by natural persons and trusts. Even non-residents are taxed – there are almost no exemptions. The DWT is a harsh double taxation. American politician Mitt Romney said: “I will eliminate the (dividend) tax entirely for those with annual income below $200,000.”

DOGS OF THE DOW: A tried and tested dividend strategy is called “Dogs of the Dow,” or the “Dow 10” strategy. “The Dow 10 strategy has been regarded by some as one of the simplest and most successful investment strategies of all time.” (Jeremy Siegel, professor of Finance at the Wharton School of the University of Pennsylvania). The strategy has been tested over the last 60 years and has returned 12.63% per year, consistently above its benchmark. The strategy calls for investors at year-end to buy the ten highest yielding stocks in the Dow Jones Industrial Average and to hold them for the subsequent year and then repeat the process each December 31. These high-yielding stocks are often those that have fallen in price and are out of favour with investors – which is the reason the strategy is often called the Dogs of the Dow. The strategy has excelled. Another natural extension is to simply apply the strategy to buy the five highest yielding stocks – it has a record of beating the S&P 500. There is no magic formula for investing, but this comes pretty close. US fund manager, Peter Lynch, said: “Never invest in an idea you cannot illustrate with a crayon.” The Dogs of the Dow strategy passes the crayon-test of Peter Lynch.

DOGS OF THE JSE: Applying the strategy to the JSE Top 40 would be an interesting exercise. At the start of 2023, the five shares in the Top 40 with the highest dividend yields were: Impala Platinum 6.99%, Nedbank 7.37%, Growthpoint 8.76%, BHP Group 9.37%, and Exxaro 12.94%. These yields are substantially higher than the current average dividend yield of 3.26% for the Top 40. We will follow the performance of these five shares in 2023. Looking back, their performance in 2022 was not too bad. Their capital appreciation during 2022 were satisfactory: Impala -7.52%, Nedbank 20.22%, Growthpoint 3.29%, BHP Group 14.35%, and Exxaro 25.62%. They have comfortably outperformed the -0.9% performance of the JSE All Share index for 2022, the -19.34% performance of the S&P 500, and the -32.87% of the Nasdaq Composite index.

BOTTOM LINE: Finally, the bad news – To comply with all the rules of SARS is an administrative nightmare. But there is good news – When you invest with Overberg Asset Management, we will do all the administration for you. At the end of the year, you will receive a “Tax Pack” with a comprehensive summary of all your transactions. Finally, some advice – do not try this at home. Dividend stocks can still be risky if you do not know what to avoid. Contact one of our consultants for a free consultation. They will take the sting out of investing.