The Magic Box Part 3

What is the use of talking about mystical cash producing boxes when it comes to the real world of investing? In this the final instalment of the series, we reveal what DividendKey students know only too well: Dividend paying stocks are just as good as magic money boxes...

Dividend Paying Stocks – your own ‘magic box’

It may sound a little ridiculous to talk about a ‘magic box’, but the fact is you could have achieved a similar outcome with any number of quality blue chips stocks, regardless of the GFC.

The trouble of course is that these assets are listed in a dynamic and fast moving market. That isn’t a bad thing in and of itself, but it does mean that the price of these assets is extremely volatile. It is this price volatility that gives people the impression that shares carry extremely high levels of risk.

This is entirely understandable; would you still be comfortable holding possession of the magic box if you discovered that demand for it suddenly dropped significantly and its going price was cut in half?

The answer here for most people is most probably no, even if the box continued to reliably spit out ever increasing amounts of cash. Indeed, many good quality shares saw a dramatic decline in value over the past few years, even though they saw no significant drop in dividends. Many people understandably panicked, but if they focused instead on the cash that was being generated in dividends, and ignored the ebbs and flows of market sentiment, they would have seen very little reason to sell at all.

Consider the case for a mix of the biggest listed companies. While there are always exceptions to the rule, the majority of blue chip stocks saw only a modest drop in dividends – many saw no drop at all.

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The average annual increase in cash payments over this period are quite impressive, and indeed most make our magic box scenario look pretty average:

Do the exercise yourself over a wide range of top 50 stocks and you will be amazed at the results – what I have listed here are by no means the exception to the rule.

Look at Woolworths. Had you bought shares at the start of 2000 you would have paid $4.87 per share. Between 2000 and 2009 each share would have paid out $5.47 in dividends. Would you care that your shares dropped 35% in the 7 months following their December 2007 all time high? In fact they could drop to zero and it would hardly be a disaster.

(Just for the record, shares in Woolworths are currently trading at over $27, representing more than a 5 fold increase in value. Including dividends you have a total investment return of 566%. But who really cares what the market currently thinks they are worth? Why would you want to sell them for? Seriously.

What if my box breaks?

As I said at the beginning, there is no guarantee that the box will continue to work, let alone continue to increase its payments. There is always a risk involved when it comes to investing, and it’s no different for magic boxes!

But what if there were hundreds of different magic boxes out there? Some would perform better than others over certain periods, and some would outright break and stop working altogether. There are certainly plenty of examples of this.

Look at ABC Learning, which the market considered to be in good shape only a year before it went bust. Nevertheless, such examples are often over stated. First listed in March 2001, it opened at 40.22 cents and over its life time paid out $1.10 in dividends. A long term investor would not have enjoyed the fact that they saw a 100% capital loss, but then again, with dividends factored in, they actually saw a net positive return!

The more important thing to note is that you can easily minimize your chance at loss by simply diversifying across a variety of boxes. If for example you purchased a number of boxes, an underperformance from one would most likely be offset by strength in the others. And indeed this is exactly the phenomenon we observe when we look at diversified portfolios of shares over the long term. You never know which share, or box, will be the best performer over the next ten years, but you can be confident that on average, they will tend to do well overall. That at least has been the lesson from history.

Income matters

The point is that with quality investments it is the income that is produced that matters. Any eventual capital appreciation is certainly not unwelcome, but this is secondary to the income potential, and indeed the eventual market value will itself depend heavily on said income potential.

If you find a golden egg laying goose (or magic box), and they aren’t difficult to find, buy them and treasure them. Many opportunities will come along where you can sell the goose at a handsome profit, but so long as it continues to lay those lovely eggs, why on earth would you? And does it really matter if you discover afterwards that you could have purchased the goose at a lower price? Does it matter that the demand, and hence the price, for golden egg laying geese rises and falls with virtually no rhyme or reason? Not really; not in the long term.

Let others speculate on what these mystical items are worth, just do what you can to own them and keep them.

To learn more about building a stable of safe and reliable cash generating assets, check out the DividendKey. At only $199 and with a 100% money back guarantee after the first lesson, you have absolutely nothing to lose.

Make the markets work for you

Andrew Page