There lure of dividends

But high yields are not necessarily good news, warns Chris Walker

Chris Walker

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SINCE THE GFC TARNISHED SHARES’ sheen somewhat – although they have had a great run since mid-2012 – dividends have come into greater focus as equities’ saving grace. Not only have dividends continued to be paid by most companies that paid them before the meltdown, returns have generally been well received by investors who otherwise might have despaired.

With dividend yields at the time of writing of 5.8% for NAB, 6.2% for Telstra and 5.7% for Commonwealth Bank before franking credits, or 8.37%, 8.8% and 7.5% respectively after franking credits, these are very attractive returns, way better than the current returns from cash or fixed interest – and, of course, with shares there is also the potential for capital growth.

Overall, according to data from Rivkin, the average dividend return from companies comprising the S&P/ASX 100 at the time of writing was 4.4%, an average 4.3% for S&P/ASX 200 companies and 4.2% for the companies in the All Ordinaries Index.

It is interesting to note the variance in dividend yields that a quick glance at the share pages reveals and to ponder why some yields are higher than others. It also raises the question, how high is too high?

According to Australian Shareholders Association’s Stephen Mayne, Australia “has one of the strongest dividend cultures in the world, mainly because of franking credits and also because we have a lot of self-funded retirees who are income dependent and hold shares for that reason”.

There are consequences of this. One is that listed companies, particularly the bigger and more heavily traded ones – the sort you could describe as blue chip – are closely analysed, profitability is known and the market is pretty quick to make a judgement if a company’s dividend payments is perceived as being out of kilter, either too high, or – way more unwelcome – too low.

Rivkin chief executive Scott Schuberg says: “An easy way to reduce the possibility of investing in a company that’s paying unrealistic dividends is to concentrate on the bigger companies, particularly those in the ASX 50. They have good corporate governance and are very closely scrutinised.

“There’s more danger in the less liquid, less covered part of the market.”

Some companies have a tradition of paying dividends at the higher end, Telstra and the big banks among them. Their popularity helps support the share price, which in turn makes the management team look good and helps keep their jobs and stock options rosy.

Everyone’s happy if dividends remain strong – to the point that some companies may pay more out in dividends than financial fundamentals suggest they should.

According to Mayne: “The first responsibility of a company is to be solvent and only pay dividends when it can afford to.

“A company shouldn’t do what OZ Minerals did during the GFC, where it paid a dividend and about six months later was almost broke. Others, including Gunns and HIH, were guilty of paying dividends to the death. At the first sign of trouble a company should turn the dividends off.”

Mayne points out that many companies, to keep their dividends looking healthy, engage in “smoothing”, where for shorter-term periods of lower (or non-existent) profitability, dividends are nonetheless smoothly increased, not jerked up and down, which can frighten investors and lead to a share price fall.

Mayne says BHP Billiton has done this, and NAB is doing it presently “where it’s paying out more than it’s making. However, NAB expects to make higher profits in the years ahead and so it’s smoothing now, and will ultimately move back to a situation where profits are higher than dividends.”

It’s also fair to say some companies are inherently better suited to paying higher dividends than others, based on the level of capital they need to run their business properly and to grow it into the future.

Mayne says if a company is mature with high cash flow and low capital demands, “such as Tabcorp, REA Group, SEEK or Tatts Group, there’s nothing wrong with a dividend payout ratio of 100% [where all after-tax profits are distributed to shareholders]. It’s reasonable for share investors to expect this.”

Schuberg says: “This trend of many companies paying strong dividends, and investors’ hunt for yield, will continue for quite some time; in fact, there’s no end in sight yet.” Encouraging – let’s hope he’s right.

Chris Walker has contributed to Money since 1999. He has co-written books with Paul Clitheroe, including Making Money, the best-selling finance book in Australia.

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