The Itchy Trigger Finger

With the FTSE hovering around 5,750, Europe in recession, a looming US election and the Fed poised to do something or nothing, it’s times like these that can really burn an investor without a plan and without the number one investor virtue – patience.

 

What do I mean by this?

 

I write these blog postings as much to help with your Child Millionaire portfolio construction as I do to prevent myself from doing anything rash and stupid. Rash and stupid in this context means giving into emotion, specifically the fear of missing out on gains, when in all likelihood the price and risk is too high.

 

When it comes to successful dividend investing your entry point into a given company share matters significantly to your overall return. If you pay too much for a share you acquire fewer shares for your money, your yield suffers and your overall dividend take is lower. The effect of paying too much up front is compounded over time because the lower dividends reduce how quickly your reinvested dividends acquire more shares and compound your capital.

 

Let’s look at an example.

 

A fantastic company and share to be holding right now is SSE (formerly known as Scottish & Southern), which is the second largest energy generator and supplier in the UK. As I’ve mentioned before, people need what SSE produces.

 

SSE recently announced that its final 2012 dividend would be 56.10p, payable in 21 Sept 2012. Coupled with the interim dividend of 24.00p paid on 25 January 2012, the total annual dividend will be a fantastic 80.10p per share. This continues their policy of upping the annual dividend year after year by 2% over the Retail Price Index (RPI) until at least next year and above inflation after that. This track record puts them in the top 5 of FTSE 100 companies in terms of dividend increases since 1999. SSE also recently raised its retail energy prices by 9% commencing 15 October 2012. Bad news for energy users, good news for SSE shareholders.

 

So far so good. I have spare cash in my ISA trading account and my itchy mouse trigger finger wants a piece of that dividend action…

 

But what about the share price and how does this affect the current yield and the long term potential return from SSE shares? And is now a good time to buy or should I wait?

 

At today’s price of about 1,375p per share, the yield on SSE based on the 2012 dividends is 5.825% [80.10p dividend / 1,375p share price], which is pretty tasty. Yet just a month ago on 25 July 2012 SSE closed at 1,294p per share after plummeting from an annual high of 1,445p only two weeks earlier on 10 July 2012.

 

Here’s how your dividend yield compares if you buy today or bought on 25 July or 10 July 2012:

 

Date Share price in pence Yield
29 August 2012 1,375 5.825%
25 July 2012 1,274 6.287%
10 July 2012 1,445 (annual high) 5.545%

 

So the difference between the best and worst yield of these three dates is 0.742%. It seems insignificant doesn’t it? But how would this difference affect the long term return in your Child Millionaire portfolio and is it worth worrying about or should you just buy now?

 

Let’s assume that you purchase £1,000 worth of SSE shares, rounded down to the closest whole share, for your Child Millionaire portfolio and reinvest all dividends over time. Let’s also assume that SSE shares appreciate at 2% per annum on average into the future and SSE continues to increase the dividend by 6% year-over-year.

 

Using the Child Millionaire calculator, here is how the results would play out over 10, 20, 30, 40 and 50 years:

 

Future Value of £1,000 worth of SSE Shares

 

End of Year 72 shares at 1,375p (5.825% yield) 78 shares at 1,274p (6.287% yield) 69 shares at 1,445p (5.545% yield)
10 £2,393 £2,535 £2,333
20 £7,943 £9,099 £7,382
30 £41,815 £53,673 £36,270
40 £429,378 £649,502 £337,047
50 £11,532,466 £22,071,225 £7,844,393

 

So for shares purchased on three different dates a mere 7 weeks apart in 2012, during which nothing changed with the company’s business model, and with a maximum difference in yield on only 0.742%, the results in the long term, which is what Child Millionaire investing is all about, are astounding. By year 10 the difference appears negligible between buying at the high of 1,445p per share and the low of 1,274p per share. A mere £202. However, because of the power of the time element of compound interest, by year 30 the difference is nearly double and by year 50 the difference has amplified nearly three fold to a staggering £14 million.

 

So like a super tanker heading for a reef or an asteroid bearing down on earth, a tiny nudge at the beginning results in a massive movement over time. The point is that all things being equal, the less you pay for a high quality Dividend Aristocrat type share, the higher your initial yield and the more dramatic the Child Millionaire outcome.

 

So should I buy SSE today for Mia’s Child Millionaire Portfolio? If I wait will the price come down to 1,274p again or will I miss the boat and look back on 1,375p as a missed opportunity as the share price leaves 1,500p in the dust?

 

I’ll be covering how you might determine what price to pay for a given company’s shares and how much is too much in some later posts. For the moment, suffice to say that with the FTSE 100 not far off its annual high, no resolution of the euro zone crisis in sight and China’s economy crashing before our very eyes, cheaper shares, even in high quality dividend machines like SSE, which tend to get pulled down with the overall market, seem all but inevitable as soon as the next crisis erupts.

 

So for now I’ll keep my powder dry and wait for a lower entry point on SSE and thus a better yield and eventually a much bigger pay-off.

 

Be still my itchy trigger finger…

 

 

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