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In an era of historically low interest rates, Australian retirees – and anyone who depends on income from their investments – have become increasingly dependent on dividends from shares.
Dividends have traditionally provided a stable, reliable income stream. But with interest rates on term deposits from major banks well below 1%, and the target rate on three-year Australian government bonds just 0.1%, investors have flocked to shares for a decent yield.
Faced with business shutdowns and the first recession in almost 30 years, many companies cut or suspended dividend payments.
The good news is that, just as the Australian economy has improved more sharply than expected, the outlook for company profits and dividends is improving.
Dividends stage a comeback
In the latest company reporting season for the half year to December 2020, CommSec reported that just under 79% of the top 200 ASX-listed companies issued a dividend. This was down on the long-term average of 86% but better than the 69% that made a payout for the June 2020 half year.
Of those 79% that rewarded shareholders, 44% lifted dividends, 18% kept them steady and 38% cut their payout. Leading the turnaround were the mining giants Rio Tinto, BHP and Fortescue Metals Group, which paid record dividends thanks to booming commodity prices.
According to CommSec, 86% of companies reported a net profit in the December half, with 60% of those increasing their earnings. In aggregate though, earnings were down 17% on a year ago.
So it’s not surprising that many companies are holding cash and adopting a cautious wait-and-see approach to dividends. With total cash holdings up 50%, if and when the dam breaks market analysts are tipping a surge in dividends payments as economic recovery gains momentum.
That’s due in part to shareholder pressure. The Australian sharemarket stands out from other markets for its high dividends and their favourable tax treatment under our system of franking credits. But directors will need to weigh up whether to tip the scales in favour of shareholders rather than investing profits back in the business.
Dividends or growth? The directors’ dilemma
When companies earn a profit, directors must decide how much to pay out to shareholders in the form of dividends and how much to reinvest in the company to grow the business.
In the decade of low economic growth following the GFC, companies took a cautious approach and rewarded shareholders with higher dividends.
But as the economy begins to recover from COVID, businesses are being urged by the government and the Reserve Bank to invest in their businesses to kick start growth.
While income-seeking investors love their dividends, it’s important to consider the bigger picture.
Dividends provide stability
Returns from shares come from a combination of capital gains and dividend income. While the market tends to focus on short-term price fluctuations driven largely by investor sentiment, dividend income is remarkably stable.
Over the past ten years, dividend income has accounted for slightly more than half the total return from Australian shares.
In the ten years to 23 March 2021, the All Ordinaries Index returned 3.94% per year on average. Over the same period, the All Ordinaries Total Return Index returned 8.33% per year. The difference is dividends, which returned 4.39% per year.
However, the historic ratio of share prices to dividends broke down over the past 12 months, due to the impact of COVID-19 on share prices.
One year on from last year’s market lows, All Ords returned 53.08% in the year to 23 March 2021 while the All Ords Total Return Index returned 57.34%. In other words, while dividends still accounted for about 4% of the total return, prices accounted for the balance. That’s an extreme example of the short-term volatility of share prices and the stability of dividend yields.
What dividend yields are on offer?
While an average 4% dividend yield for Australian shares looks attractive beside a term deposit rate of less than 1%, many companies offer even better yields.
The table below shows a selection of companies with some of the highest dividend yields as at 22 March.
Note: This is not a recommendation for these stocks. It is simply a snapshot of some of the best yields available on the day. During periods of high market volatility, yields can move significantly from day to day.
|Company||Dividend yield %||Gross yield %|
|Betashares Global Sustainability Leaders ETF||10.08||10.08|
|Fortescue Metals Group||9.19||13.12|
|Cromwell Property Group||6.82||6.82|
Source: Marketindex.com 22 March 2021
Dividend payouts are expected to rise as the economy recovers, which is good news for investors struggling to find a decent yield in a low interest rate environment.
While dividend income is an important factor for many investors, you should always do your own research on a company and look beyond one performance measure.
The focus for share investors should be on selecting companies with quality assets and strong management teams, good growth prospects and sustainable earnings. This is what will determine the future growth in dividends and/or the share price.
Relying too heavily on dividends from Australian shares could also mean missing out on opportunities elsewhere, not to mention a lack of diversification across your portfolio.
For example, international shares outperformed the Australian market over the past year. While dividend yields are traditionally lower on overseas markets, investors benefit in the long run from exposure to high growth market sectors such as technology that are not well represented on the ASX.