Market commentators have been highlighting the attractive opportunities for investors through targeting a high income return from Australian shares. However, given the current global market volatility, questions are now being raised as to whether the pursuit of a high income return has run its course, or whether other investment themes should be targeted in the future.
This newsletter will highlight the reasons why the pursuit of a dividend yield will continue to be a focus for investors in Australian equities, and why it will continue to make an attractive investment in the future.
Reliability
Dividend policy is an important mechanism which company boards use to signal their view of the corporate health and future outlook of the company, as well as the type of corporate strategy being pursued by the company.
The dividend policy of a company gives a guide to current and potential investors as expected future shareholder returns.
The graph below shows that Australian dividend paying companies have a strong history of working to maintain or increase the level of dividends they pay to shareholders. Most importantly, during periods of market instability (such as between 2008-2011) dividend paying companies increased the proportion of their profits which they directed to dividends in order to maintain the level of dividend payments to shareholders at the same level, even though total profits were less. This is a key indicator that dividend income is a reliable and consistent source of return for investors.
Australia Dividend Payout Ratio as a % of Earnings
Source: Thompson Reuters Data Stream
Combine with Capital Growth for Higher Potential Total Returns
A common theme from market commentators has been the thirst among investors for strong income returns in an environment of declining interest rates. The graph below shows that as interest rates have fallen recently, bringing down the rate of income on bonds, the rate of income from dividends has increased and is currently outperforming bond yields in their own right.
Australian Bond Yield vs Dividend Yield
Source: Thompson Reuters Data Stream
Many commentators have suggested that, given that the worst of the negative global economic conditions seem to have passed, dividend yields may grow even further as company earnings recover and increase leading to potential growth in dividends.
In addition, positive re-pricing of high dividend companies by investors targeting yield has also provided strong growth in capital value of the underlying equity asset. Strong capital growth combined with healthy yield from dividends delivers very attractive overall combined returns to investors.
Conclusion
There are sound reasons for investors to seek income based returns through dividend paying equities. Australian companies have a reliable track record in paying a high proportion of profits as dividends. In addition, recent favourable repricing of high dividend stocks by yield seeking investors has resulted in growth on the capital side of total return from equities while the improving global economy has signalled possible growth in dividends.
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