The vital role of payouts

FEW people buy shares just for the dividend. If you want income from your investment, the standard advice is to put money on deposit or in fixed-interest stocks - known as bonds.

Financial writers are guiltier than most in recommending shares for their capital appreciation. Tipsters measure performance on how much the shares have risen. A better guide is the total return - a combination of dividends and capital appreciation.

Dividends are vital. They provide an income stream for long-term investors, notably pension providers and life companies with 25-year to 40-year time horizons.

The most infamous decision by Gordon Brown since taking office was removing the tax break to pension funds on dividend payments to corporations. Authoritative estimates suggest this has cost pension funds £100bn in the period since Labour took office.

The annual Barclays gilts-equity study - the bible on investment returns - leaves no doubt about the significance of dividends to savers. It found that £100 invested in shares in 1899 would be worth £142 now. But were the dividend income reinvested in the stock market the return would be £14,847, more than 100 times greater. In fact, the only investment that has outpaced inflation over the decades is the total return on shares.

This does not mean companies should be bribing shareholders with a dividend at the cost of all else. It makes no sense to over-deliver income and starve the enterprise of capital to expand the business, ultimately driving it into bankruptcy. So very high dividend yields can signal danger.

Warren Buffett never pays dividends through his firm Berkshire Hathaway. He argues that an investment company should produce capital gain by the skill of its stock picking - and he has done it in spades. This does not mean he disapproves of income distribution to shareholders.

He argues instead that dividends should be 'consistent and predictable'. Payments should reflect long-term expectations for earnings and returns on capital. There is no point in hanging on to retained profits for the sake of it.

Dividends are as critical as earnings in judging investment performance. As Buffett noted in a shareholders' letter in 1986: 'If earnings have been unwisely retained, it is likely that managers have been unwisely retained too.'