Focus on total return not just yield

Since the beginning of the financial crisis, investors have seen pitiful yields on cash deposits as central bankers have reduced interest rates to near zero.  As a result, investors have been forced to look elsewhere in their hunt for yield.

The trouble is many of them have been overly focused on cash yields in their search for more attractive alternative investments.  In my view, they have been missing out as a result.  As a former private equity investor, I believe investors ought to be looking at total return and not just the narrow measure of running yield.  After all, what matters most is overall cash on cash return.

I am not suggesting dividend yields are unimportant.  I’m simply saying that they are only part of the picture and that an undue concentration on dividends can lead to less than optimal returns.  Let’s take a look at a few examples to bring out my point.

REITs and utilities stocks have seen large inflows of investor cash in recent years, attracted, no doubt, by their generous yields.  For example, Vanguard’s REITs and utilities exchange traded funds are showing current yields of 3.5% and 3.4% respectively.  These same ETFs have seen annual total returns (including yield and capital growth) of 14% and 12% over the last five years.  Not bad, but let’s now consider a couple of solid stocks that may have been overlooked by income seeking investors simply because of their meagre dividend payouts.

Zimmer Biomet is a medical devices company with a current dividend yield of only 0.7%.  However, its annual total return for the last five years has been 20%.  And take a look at Visa, the credit card company.  Here’s another investment that may have been overlooked because of its relatively poor dividend yield of 0.7%.  Yet its annual total return for the same five year period has been 29%.

If investors need annual cash income, dividends are not the only way to achieve this.  An alternative source of cash could be generated by selling a portion of their investment to realize a capital gain.  Indeed, in many countries, capital gains are taxed at lower rates than dividend income.

Next time you consider a potential investment, my suggestion is that you focus on total return not just yield.