Dividend investing works. According to the Barclays Equity Gilt Study, if you'd invested £100 in the UK stock market in 1945, the shares would have had a nominal value of £9,148 after inflation in 2015. However, if you'd reinvested all dividends received over the last 70 years, this figure would jump to an astonishing £179,695. That's the power of compound interest.
With this in mind, let's look at one rising star and two established giants on the dividend scene.
Since March 2015, shares in Auto Trader(LSE:AUTO) have accelerated from 265.5p to 409p this morning. Today's full-year results were packed with more good news for its investors. Revenue was up by 10% to £281.6m, reported operating profit increased by 27% to £169.6m and earnings rose by 0.85p per share to 12.67p.
Importantly, net external debt was down by £135m to £393m. The reduction has contributed to the board's decision to propose a final dividend of 1p per share. The company also announced that a rolling programme of share buy-backs will "commence imminently, with the majority of surplus cash after dividends being returned to shareholders." This all sounds very promising.
A total dividend of 1.5p per share may seem rather measly but this could rise quickly if the company continues to generate excess cash flow, bearing in mind that the rate of dividend growth is arguably more important than the size of the actual dividend. A rapidly rising dividend suggests that all is well. A stagnant or sky-high payout suggests that a business is treading water.
So long as the company can continue its stellar performance so far, I see Auto Trader as an excellent medium-to-long-term choice for growth and income investors.
A more traditional income play is GlaxoSmithKline(LSE:GSK). Big pharmaceuticals have almost sacred status among dividend investors for being just about the most defensive shares you can buy. Despite (or perhaps because of) rising life expectancy, people will always need medicine.
That said, the recent performance of GlaxoSmithKline's shares has been uninspiring. The concerns arising from patent expiries haven't gone away and the lack of information regarding Sir Andrew Witty's successor hasn't helped. While a vote to remain in the EU may give the price a boost of some kind, I'm not expecting fireworks.
Nevertheless, with a yield of 5.63% for 2016, GlaxoSmithKline remains a decent, solid choice for most income investors, even if the level of dividend cover (1.08) needs to rise soon.
Payout in doubt?
On Monday, regulator Ofcom accused Vodafone (LSE:VOD) of failing to have proper procedures in place for handling complaints. Ultimately, it could be fined 10% of its turnover for this. Even more worrying is the fact that Vodafone is the most complained-about network in the UK. If I still held its shares (sold November 2015), the news would concern me.
For some time, one of the few attractions of owning shares in the £62bn cap has been its dividend yield. For 2017, the forecast yield is very close to 5%. Here, the cover ratio is just 0.5, according to Stockopedia. This means that Vodafone will likely be forced to dip into reserves to fund the payout. This can't continue indefinitely. While capex spending has reduced following the completion of Project Spring, earnings must improve substantially at some point or this payout will need to be reduced or cut completely.
So, would I repurchase Vodafone today? Not a chance. The concerns over its ability to fund the payout aren't helped by the very pedestrian performance of its share price. While Glaxo's yield looks more secure, the clear winner for me (and perhaps those with fairly long investing horizons) would be the disruptive, fast-growing Auto Trader.
History may have shown that dividends can play a major role in building wealth over the long term. However, this strategy only works for as long as dividends can be sustained. If a company runs into trouble, these regular payouts are often the first things to be sacrificed. This is why a detached and dispassionate evaluation of any company should happen before you should consider purchasing its shares.
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Paul Summers owns shares in Auto Trader and GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Auto Trader. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.