The Dividend Peril of following the herd
by Mark Causer
With global economic growth forecasts being revised downwards, global interest rates at all-time lows, the insatiable appetite for yield, some might argue, has become more desperate.
This of course is by no means a new story, but one that should be monitored closely.
At Financial Keys we believe that it is a sound business and investment principal to occasionally and selectively challenge the status quo.
Let’s take for example, Australian company payout ratios and their dividends, one area that many investors expect and follow without question.
Recently (30/3), the Australian Financial Review reported that “the payout ratio for the ASX 200 is at 106.3%. What this means is that “payments to shareholders (dividends) exceed the value of profits that companies make, compared with 65% five years ago. This figure is unsustainable.” Furthermore, “despite the high payout ratio, the actual dollar-amount of dividends is tumbling as corporate profits weaken.
The $19 billion in interim dividends to be paid out for the latest half year results is around 20% below last years”. The ASX 200 dividend yield is 4.94%, which is slightly off the highest levels since the GFC in June 2009.
It should be worth noting that one company, CBA, is paying out $3.4 billion alone.
For close to two decades, Australian companies have been world leaders with consistently high payout ratios between 60% - 70%, beating the UK, the US, Japan, Europe and Canada. This has been aided by the introduction of the dividend imputation system in July 1987. This system ensuring no double taxation of dividends i.e. taxed at both the company level and the individual level.
Additional legislative changes along the way have only added to this attractiveness (refund of excess credits and the Zero tax environment for super funds in pension phase to name two) and in some cases has caused investors to have a country bias (i.e. to Australia) as well as a sector of the market (i.e. ASX 20).
So why is this important to me?
Let’s first quickly look at these two……
A dividend is a payment made by a corporation to its shareholders, usually as a distribution of profits. When a corporation earns a profit or surplus, it can either re-invest it in the business (called retained earnings), or it can distribute it to shareholders.
By way of comparison, the Dividend Payout Ratio is the fraction of net income a firm pays to its shareholders in dividends. That part of the earnings not paid to investors is left for investment to provide for future earnings growth.
Investment advisers are particularly interested in the dividend payout ratio because they want to know if companies are paying out a reasonable portion of net income to investors. For instance, most startup companies and tech companies rarely give dividends at all as most of their profit / earnings is ploughed back into growing the business. In fact, you might be interested to know that Apple, a company formed in the 1970s (a global giant), stopped paying dividends in 1995, only to pay their first dividend to shareholders some 17 years later in early 2012.
Conversely, some companies want to spur investors' interest so much that they are willing to pay out unreasonably high dividend percentages. An astute investor would spot that these dividend rates can't be sustained for very long because the company will eventually need money for its operations – they may then need to borrow.
High payout ratios resulting in high dividend yields can hide the fact that there is little or no underlying growth within the company. It is financial fundamental that to sustain higher dividend yields, a company must grow, without growth, increasing payout ratios only delays the evitable crunch.
These attributes above are not lost on Financial Keys when we are preparing investment portfolios and making investment recommendations to you our clients. We will not and do not simply follow the herd, we do challenge the status quo – regularly.
We fully appreciate that if we focus too much on client demand for yield, we run the risk of missing out on the value of accretive growth opportunities.
Sources: AFR, Commsec , The Bulletin
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