About – Investing for Income

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Transcription

Alright, so this principle I call the investing for income principle and this is probably one of the most misunderstood principles out there because a lot of people think that income is really an important part of return and that’s true, but a lot of people misunderstand how income is actually generated, and particularly the effect of income growth in the amount of income that’s paid out of investment. The way I like to look at this is there’s the income, that is the payments you’re going to receive, the rent you’re going to receive from your property, the dividend you’re going to receive from your shares. Then there’s the yield, and that is what is that income as a percentage of the overall capital. If it’s worth, you’ve got a company worth $100 and it’s paying a $5 dividend, then it’s got a 5% yield. And yield and getting yield equivalencies is a very important part of how we look at the relative value of investments. But what ultimately drives that yield or the appropriateness of a particular yield is the growth in that income. So not the $5 that the company’s going to pay you in the next 12 months, but how much they’re going to pay next year and the year after and the year after and the year after. it’s like $5, 5% of your $100, $5, but then next year it’s $150 because they’ve grown. – Well no, so not the growth in the price of the shares. That ultimately becomes a function of the price, of the growth in the income. So it’s this year I’m gonna get paid $5, but how much dividend am I gonna get next year? Is it gonna be $5 again? Or is it gonna be $5.20, $5.50, $5.60, $7? How much is my dividend going to increase? how much is the profits of the company gonna increase over time, at what rate? And it’s a growth in that rate of income that matters. Because if 5% is the right yield, i.e. the share should be worth essentially 20 times the income they pay, and that $5 grows to $10, well then the share price is gonna go from 100 up to 200. – Yep. – Okay. – And that’s, yeah. – Okay, because it’s still worth the same, okay? So, but, if the yield, If I’m getting $5 for a $100 share, but the growth in the income is actually so slow that in reality I really should be getting a 10% yield, then the real share price is $50. – Yeah. – And only 10 times that. And so that $100 price is gonna get to 50. – Yeah. – At some point. – Yeah. – Okay? So getting the yield right is really important because a lot of things that are high yield, i.e. the income they’re paying in the short term is relatively high, is because the price has dropped or is on its way down. – Yeah. – Okay, and that $5 is actually gonna be $4 next year. And so yes, it’s paying a $5 dividend and you can get it for 20, but next year the dividend might be one or two. – Yeah. – ‘Cause this company’s actually on the way down. So it’s high yield now, but it’s the yield growth. It’s that growth in income that matters, right? – Yeah, okay. – And the way that plays out actually, is let’s look at an example of looking at different types of investments. So in this case, we’re looking at four different shares 15 year period, right? So in this case we’re looking at Telstra, National Australian Bank, ComputerShare. This is particularly important for people who are retiring. People who are retiring often think, well now I need cash flow, okay? And therefore I need access to income, okay? And income and cash flow are fundamentally different things. And we talk about that in a different principle. But I want cash flow. But so they equate that, therefore I need income. So what’s buyer stock that pays a nice yield? Lots of income, right? I need income stocks. and the income assets, ’cause income’s what I want. And what I want is cash flow. – Yes. – Right? – Yeah. – And cash flow can be income, it can be capital, right? Can be both, but what I want is cash flow, and I want sustainable cash flow, and I want the maximum amount of cash flow. But people mistake that for thinking, well, I’ll just need income. So let’s look at this example. So here’s Telstra’s paying a 9.4%. That’s the average yield over 15 years of Telstra. – Yeah, it’s great, right? National Australian Bank average yield of 9%, right? 9% is great, you can get that, you’re pretty much done. Whereas ComputerShare over the 15 years only had an average yield of 3%. And Ramsey Healthcare had an average yield of 4%. Okay, but let’s have a look at how that played out, right? So let’s look at the actual dividend franking credit income. So I invested $10,000, okay? Over 15 years, the total amount of dividends paid from Telstra was 13,000, 13,500. NAB was a bit less, only paid 11,800. The dividends I had from ComputerShare I got was 21,000, and from Ramsey it was 35. So despite the fact that these shares’ yield was lower, the total amount of income they paid was a lot higher. So this is looking from 2003 to sort of 2018, over a 15 year period just with these four stocks. But here’s basically what happened. So let’s look at Telstra and Computershare over that period of time. So here’s the yield in the first year. Telstra got a lot more income back than they got from Computershare. About twice the initial income, hence much higher yield. But here’s what happened over the next 15 years. So Telstra’s amount of dividend I got actually didn’t go up at all. No, it stayed the same. Right? OK. And in fact, the share price went down a little bit, which helped push the yield up. Because yield is a function of income and share price. So the share price goes down, the yield goes up, even if it’s the same dividend. So what you want, you don’t want yield, okay? You don’t even want income. You want total cash flow. In this case, computer share grew its dividend quite strongly, flattened out a bit here, and then it was higher at the end. So look at the difference in terms of trajectory. So that’s why computer share paid so much more income over the 15 year period in Telstra. So if you’re looking at this in hindsight and said, “Well, I want income,” which one’s an income stock? – The low yielding one. – Yeah. – Right? And it’s low yielding. – It’s counterintuitive though. – It is a bit counterintuitive, until you understand that the reason it’s a low yielding stock is because its ability to grow its income is thought to be much higher by the market. So the market said Telstra, you’re not gonna pay me anymore, so I want 9%. – Yeah. – Whereas they said, Computershare, you guys are on a roll, you’re gonna make lots more money in the future, 3% is fine. – Yeah, we’ll take that. – I’ll take the extra along the way. Now what do you think happens to the share price over that period of time as well, right? – Oh, they should have asked for it, yeah. – So let’s look at Telstra versus CSL. This is another example, right? So in this case, I’m looking at Telstra’s cash yield. This is their cash and their franking credit. So you can see the yield sort of bounced around a fair bit. This is going from 20 years from 2001 up to 2021. But the yield roughly around, again, that sort of eight, 9% average rate, right? – The bridge jumps. – Okay, but here’s their yield on the initial investment, right, but because that hasn’t gone up much, Neither has the amount that, as a function of the initial investment. Basically, you’re getting the same cash flow all the way through. – Yeah. – Here’s CSL’s aggregate yield over time. You see the yield goes up a fair bit here, and it starts to come down, the yield starts to come down because it’s a function of the share price mostly going up. And now, CSL becomes a very low yielding stock. – Yeah. – But look at the yield on the initial investments. In other words, look at the level of dividend you’re receiving over time. The dividend’s gone up quite substantially. – 2% of 200,000 is better than 15% of 10 grand. – Exactly, right? And then here’s what’s happened to the capital, right? So Telstra at the start, if we even these out and said, okay, both of them are gonna give you the same amount of, the same investment, right? So $100 initial investment in Telstra. Here’s the dividend, okay? So by the end of it, CSL, the yield initial is 17.7%. So if every $100 you invested, you’re getting nearly $18 back per year now in dividend. Okay, for Telstra, the gross yield on initial investments now 4.2%, so for every $100 you put in here, you’re getting $4.20 back, right? So you’re getting over four times the amount of cash flow now down the track. Now, not only that, your $100 in Telstra’s dropped to 70, and your $100 in CSL’s $1,800. But that aside, cash flow is a driver of that, right? It’s the earnings that have got you to that point. – Yeah. – So it’s really important to appreciate that when you’re investing for income, you’re investing for income over the time, not for the yield in the first year. – Yeah. – ‘Cause it can be obviously very misleading and punishing in your long-term investment returns. – Yeah.