A dividend-focused investment solution can be a valuable addition to an investor’s overall equity portfolio in both bull markets and bear markets, broadly improving its diversification and quality characteristics.
However, caution is required when choosing the underlying stocks, because a high dividend is not always a sign of a healthy business. Additionally, in South Africa the performance of high-dividend-paying stocks has not proved to be as clear-cut a benefit as it has in the United States.
In the last part of this article, we contrast this investment strategy with that of growth investing, providing some practical examples.
Please click here to read the first part of this article.
Identifying high-dividend companies: A mindful approach
A simple metric widely used to identify high-dividend-paying businesses is their dividend yield (DY), which comprises the company’s annual dividend per share divided by its share price.
In broad terms, the higher the dividend yield, the more attractive the investment case for those wanting to earn a steady income from their equity investments. Investment analysts also consider DY to be a reliable indicator of a company’s stability and general financial health.
However, there are several reasons DY cannot be used as the sole metric for choosing a share in which to invest.
First, a company’s share price may have been falling, giving the impression of a higher dividend yield and possibly masking negative issues in the business.
Second, DY is simply a snapshot of a company’s health at one point in time – consideration has to be given to the company’s dividend policy, its dividend payment history, and the sustainability of its cash flows going forward, as well as its future growth and investment plans. Here, metrics such as the forward dividend yield, five-year compounded dividend growth rate, five-year total return, and payout ratio all add essential insights into understanding a business’s financial health and dividend growth potential.
A third consideration is the risk that a company’s dividend payouts are too high to be sustainable – it is possibly underinvesting in research or other key inputs for expansion and consequently limiting its growth potential, instead opting to reward investors immediately.
A high dividend could also indicate greater potential for a cut in dividends going forward.
And finally, companies may be using generous dividends as a way to bolster investor confidence and disguise operational weaknesses, as was the case with Steinhoff.
What about low-dividend-paying companies?
Low-dividend-paying companies, meanwhile, invest significantly higher proportions of their profits back into their business. This may be necessary to underpin rapid expansion, capture a growing market share, or improve their products and services, among other purposes. These “growth” companies are usually in an early stage of their development, focusing on a new market or technology, or exploiting a new gap in an existing market, all higher-risk activities.
Here investors will typically encounter higher levels of corporate debt, because growth companies may need leverage for additional funding. And importantly, their investment returns rely largely on share price appreciation, making them much more dependent on sentiment-driven equity markets. As a result, growth stocks are likely to display higher volatility than their dividend-paying peers, making them more uncomfortable for shareholders to hold onto in down markets.
Technology stocks are the best examples of growth companies, particularly in the current environment of accelerated innovation, and they have captured the financial news headlines for their extraordinary share price escalation in recent years.
Globally it has been the tech-heavy NASDAQ 100 Index that has outperformed all others, beating the more diversified S&P 500 Index over the past 10 years (to May 2025) with an annualised average total return of 17.6% versus 12.9%.
With far fewer growth companies in the FTSE/JSE ALSI, this outperformance has not been as evident in South Africa over the past decade. The ALSI has produced a total return of 9.8% a year compared with 7.9% a year from the FTSE/JSE Dividend Plus Index (J259).
ALSI returns have been boosted by the strong share price growth of its largest holding, Naspers (and Prosus), thanks to its partial ownership of Chinese technology group Tencent. Although it is difficult to calculate the company’s exact average share price growth in the past 10 years because of its unbundling of Prosus in 2019, it is estimated at 17% a year (source: Google AI).
Does the DIVI Plus Index protect South African investors?
In financial market downturns, data for the US equity markets shows that the S&P 500 Index, with its blue-chip companies, has protected investors’ capital more than the growth-focused NASDAQ 100.
In the 2008 global financial crisis, the S&P returned –37% versus the NASDAQ’s total return of –41.5%, while the post-Covid period (2022) saw a return of –18.1% from the S&P compared to a substantial 32.6% loss from the NASDAQ.
Looking at the metrics for the South African equity market in the table, we can see that the DIVI Plus Index has not outperformed the ALSI in recent periods, nor has it been less volatile or had lower drawdowns on average (to June 2025).
Additionally, its lower return/risk ratio makes it a less appealing investment than its ALSI counterpart, because it indicates a lower return per amount of risk. It did produce higher annual returns than the ALSI in the financially difficult years of 2018 and 2022, however.
In conclusion, based on local market characteristics, South African investors would be well advised not to expect high-dividend-paying shares to offer the same portfolio benefits (or to the same degree) as those found in larger, more developed, and faster-growing markets such as the US.
Although a dividend-focused strategy can offer diversification benefits and a regular income for investors prioritising income overgrowth, it may not be as appealing for longer-term investors looking for faster growth.
And finally, when choosing a high-dividend-paying solution, the key for investors is to find companies that allocate their capital wisely and effectively to finance their future growth, while also paying a sustainable and growing dividend over time.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article does not constitute investment or financial planning advice that is appropriate for every individual’s needs and circumstances.
