Having recently celebrated his 90th birthday, Warren Buffett has become an almost Confucian figure for investors. While the 6th century BC philosopher told us “The man who moves a mountain begins by carrying away small stones”, the ‘Oracle of Omaha’ famously noted that “someone is sitting in the shade today because someone planted a tree a long time ago”.
They may be thousands of years apart but they both embrace the long term, look to the future and stick to the plan. Slow and steady wins the race. Of course, the problem with slow and steady is that in times of upheaval it’s easy to get derailed and start making rash decisions. This year has brought many challenges, among them a bad year for income investment and those accustomed to dividends.
Even Warren Buffett hasn’t had a great year, but he’s been around for decades and that’s the point really. Let’s look at what we can learn from his approach.
2020 isn’t paying dividends
The negative news story for income investors this year is that many companies have simply had to suspend paying a dividend in the face of what 2020 has brought to the table. There are some big names among them. In the energy sector Royal Dutch Shell and BP have had to take a rain check, while in the automotive industry both Ford and General Motors have followed suit. Then there’s travel, one of the hardest hit sectors of all. Many large companies that depend on the ability of people to leave their homes for fun have had to defer dividends, including Boeing, Delta and American Airlines. Even Walt Disney has had to postpone wishing on a star this year.
It’s not all bad news – in fact, for some big names dividends have actually increased, with Johnson & Johnson and Proctor & Gamble being two examples, but that’s not the point. At Citywide we have a set of key investment principles that guide everything we do, and among these are absolute dedication to long-term thinking (for you and for us) and the acceptance of bumps along the way that we must plan for and deal with.
Where Buffett comes in
As we mentioned, 2020 hasn’t been a big win for anybody, not even Warren Buffett whose portfolio includes some of those airlines and oil companies. To be fair, Buffett is probably making ends meet, after all he’s a very wealthy man, but it’s more about the systematic approach he’s taken over the years. Mr Buffett, you see, does not like dividends.
In the book of Buffett, the goals are long term and the progress is strategic. The companies that represent the best bets are those that dedicate themselves to funnelling profits back into the business, making themselves better able to provide for investors through capital growth. Even Buffett’s own company Berkshire Hathaway has paid a dividend only once, way back in 1967, a decision he claims was made “while he was in the bathroom”.
There’s evidence elsewhere to suggest Buffett is onto something. There’s a misconception that high yield stocks are always a good thing. Some investors build a portfolio of the highest dividend-paying stocks then sit back to enjoy the ride. That’s the essence of income investing, right? The problem is the highest yielding stocks don’t necessarily give good long-term outcomes for income investors. To understand it, we need to remind ourselves what dividends are – a share of the profits. With that in mind, a high dividend yield may not be a good sign, because if a company is consistently returning lots of its profits to investors, it’s not using that money to grow.
It’s also telling that companies whose balance sheets show higher levels of debt tend to be at more risk of cutting dividends, while conversely, those with defensive business models built on long-term thinking (and with stronger balance sheets) tend to fare better.
One last consideration is what’s known as ‘concentration risk’. That’s not the danger that your mind will wander off from your long-term strategy (although that’s an important point in itself), but the name given to putting too much of your money into similar types of investment. The important point about concentration risk is that similar investments are likely to move the same way at the same time – in other words, it’s the opposite of a well-diversified portfolio.
Of course, investing for income means investing in companies that pay dividends. Income investing is a thing and we’re not about to admonish those who want to get a steady source of money from their investments. What’s important is that long-term thinking applies just as much whether your goals are income-based or centre on long-term growth. Income investing vs. investing for growth isn’t just about ‘money now vs. money later’, both approaches require strategic long-term thinking and a properly diversified portfolio that delivers the results you want far into the future.
While we all malign ‘2020′ as though it’s a trademark, we need to remember that the effects and economic impact are likely to affect dividends for some time. We can expect a recovery at some point, but we can’t say when, nor can we be certain that the ‘normal’ we return to will resemble the ‘normal’ we left behind. Companies will be working with lower profits and therefore lower dividends, but also recalibrating their own approach to the future.
So what can we do moving forward? Let’s go back to Buffett. If you’re investing for income the dividend yield is a a big draw, but let’s learn the lessons of 2020 and take a longer-term view. Buffett believes that buying into a business means buying into its model and management. It’s a good time to review the approach of the companies we’re invested in, their management of capital, their vision for the years ahead.
But let’s also remember the importance of diversification and long-term thinking. At the moment we’re seeing a range of hot tactics among fund managers – some are targeting dividend-paying companies in Asia. Others feel the best growth opportunities will come from companies that suspended dividends, because share prices may recover when payouts restart.
As ever, we believe the best approach isn’t to be found in a whim or knee-jerk reaction. Times have been tough, but by focussing your attention on long-term growth, you’ll be investing in businesses that are more likely to stick around, and ultimately, those best-placed to start paying dividends in future.