By MARY HOLM
Q. I found an article in the Herald this week by Ellen Read disturbing.
She says New Zealand stock is getting overvalued and "the capital NZSX-all index is at 908.5 - its highest since October 1997 and just below the all-time high of 921 just before the 1987 crash".
I only have New Zealand dividend-yield stock in case the market crashes, as I have been told I will still get my dividend whatever happens and, eventually, they will rise in value again.
I think I would still find it hard not to panic if my Contact Energy shares were suddenly worth 50 cents each.
What do you think of the high position of the market at the moment? Are we in danger of a crash?
A. I don't know. I could ring lots of market analysts and report back what they said. But history shows that nobody is all that good at predicting share market movements.
Having said that, crashes tend to follow periods of extraordinary growth. And we haven't had that.
The fact that the index is close to its 1987 peak is nothing to worry about. If anything, we should worry that it didn't get there years ago. Most of the world's big share markets topped their 1987 peaks within a year or two of the crash.
True, the boom before the crash was particularly strong here. New Zealanders borrowed to invest in shares in companies that, in turn, borrowed to invest in other companies. Such gearing on top of gearing is highly risky. But that's not happening now.
If you look at long-term share market trends, they are always upward. In a normal scenario, without the '87 crash in the relatively recent past, a share market will break through its all-time highs fairly often.
Note, too, that nobody in Ellen's July 13 article said the market was overvalued. Analyst Arthur Lim said: "NZ equities are no longer cheap", but that's not the same thing.
Stop worrying about an imminent crash - although a milder downturn is always a possibility. I do have other concerns about what you say, though: you can't be confident that any one stock will rise after a crash. If the company goes belly up, the share will be worthless forever.
Whoever told you shares will rise again would have been referring to the market as a whole. If you hold a wide range of shares - preferably 20 to 50 - either directly or via a share fund, the value of your total share investment will indeed recover if you hold on for long enough, because some shares will do well.
You won't still get dividends whatever happens. Companies quite frequently reduce their dividends. And, of course, if they fold, the divis end.
If your share holdings are not well diversified, I suggest you change that. Even with no crash looming, holding just a few shares is riskier than necessary.
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Q. I am an equity investor in a modest way but you would undoubtedly say I have too small a portfolio with one bond issue and six shareholdings spread over property and manufacturing, retail and a lines company.
However, it is compact, and I can keep in close touch with the companies. My requirement is best earnings with minimum risk. I guess most retirees would place dividends and interest high in their requirements, keeping a balance between imputation-bearing shares and interest, so that the unused tax credit to carry forward does not get out of hand.
Seems that the best dividend investment companies are usually good for growth, too.
A. You're right. I would rather you held more shares. Still, six is much better than many people, who hold one or two shares. And your spread over different industries helps.
The diversification, limited though it is, not only gives you some protection if one or two companies go bad, but it also smooths the dividend flow.
As I said above, you can't count on dividends not changing. But it would be surprising if all six companies cut their dividends at once.
Many retirees, I suspect, would hold more interest-bearing investments than you do. What's best depends on your other sources of income, your tolerance for risk and so on. It certainly makes sense to have enough non-dividend income to absorb the imputation tax credits, as you say.
What intrigued me about your letter, though, was the idea that shares in companies that pay high dividends are likely to grow fast.
When I was studying finance, we were taught the opposite. A company either pays out its profits in dividends or retains the money. All else being equal, you would expect the shares of a company that reinvests its profits in its business to grow faster.
However, more recent US research (by Robert Arnott and Clifford Asness) found: "The historical evidence strongly suggests that expected future earnings growth is fastest when payout ratios are high and slowest when payout ratios are low."
Are these two inconsistent? Not necessarily. I said, above, "all else being equal". But what if the companies that pay higher dividends are, on average, stronger? The high divis might reflect good cash flows and management confidence about the future.
Meanwhile, low-dividend companies might be either in financial trouble or small and growing, so they need to keep all their profits for expansion.
While some small companies will do really well, others go bust. So, on average, low-divi companies may not have such good growth prospects.
It's quite feasible that, while paying high dividends is not good for a company's growth, it's a sign that a company has good growth prospects anyway.
Don't carry this too far, though. If you invest only in high-divi companies, you'll miss out on the big winners among the small growing companies.
Also, as ABN Amro Craigs points out, a portfolio of high-dividend shares is "highly susceptible to rising interest rates". As investors switch to fixed interest, share prices are likely to fall.
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