Dividends are probably the easiest thing to understand about investing. This is how business owners make money, after all. When a company they own makes a profit, they take the money. What are shareholders if not part business owners?
However, listed companies aren’t required by law to pay dividends*. Whether they share their profits depends on a variety of circumstances. If a listed company doesn’t feel like paying dividends, it doesn’t even have to give a good reason.
As investors, we would love to invest in companies that often pay us. However, since it’s not a requirement, there’s nothing we can do to guarantee a dividend payment. Some companies may have paid dividends every year before you bought shares, but nothing compels them to keep doing so this year.
This is what makes it so difficult to construct a successful dividend-centric ETF. ETFs are rules-based, while dividends aren’t. Have a look below at the top five dividend-paying ETFs for the past year below:
We have two dividend-centric ETFs in the market and both of them are in the Top 10. However, the CoreShares Preftrax ETF, a weird little Franken-ETF that invests in preference shares (debt instruments like bonds), is in the lead. Payouts from preference shares are technically coupons, but they invited themselves to this dance so we just have to deal with it.
Quite a ways behind we have the CoreShares Divtrax ETF, an ETF that includes companies that have consistently paid and increased dividends for the past seven years. Companies are equally-weighted and included based on the actual dividend payment amount as opposed to dividend yield.
Dividend yield is a problematic metric. It’s the dividends paid as a percentage of a company’s (or ETF’s) share price. If a company with a plummeting share price issues a dividend, their yield would be astronomical, but the company would still be falling off a cliff.
However, the Divtrax ETF set out to be a high dividend payer, and in the local landscape it’s holding its own.
Next in line, however, is an ETF that never tried to be a dividend rockstar – the Ashburton Midcap ETF. This ETF invests in JSE-listed companies that aren’t included in the Top 40. It’s not trying to be a high dividend payer. It’s just minding its own business and money is falling out.
The Satrix DIVI ETF is another dividend-centric ETF, but this time constituents are included based on their forward dividend yield. Forward dividend yield is calculated by taking the previous dividend payments and annualising it. The expected future payment is divided by the share price to get the expected dividend yield. Hopefully you can already see the two glaringly obvious problems with this:
- Companies don’t have to pay dividends, regardless of what they did the previous year.
- If a company has a high dividend yield from the previous year because it’s share price fell down a well, it’ll be in the index.
Next up, let’s slow clap for the Shari’a 40 ETF. Literally the only reason anyone buys this ETF is because of religious conviction. However, money is falling out of this ETF at the same rate as the Satrix DIVI! If you had asked a Shari’a 40 investor whether they expected their ETF to throw dividends their way, they probably would have said no – not because compliant companies aren’t good companies, but because that’s not the point of the ETF.
Just to tickle you further, the next five in line are below. If you can spot a trend, make sure you tell someone who can pay you a lot of money.
When you make ETF decisions, forget about the dividend withholding tax and whether that should be your consideration in your tax-free account. Opt for an ETF whose methodology makes a lot of sense to you. That’s something you can count on.
*This seems like a dreadful oversight.
*Since property is a different asset class, REIT ETFs don’t form part of this list. Next week we’ll look at the big property spenders.