By John Collett
The remarkable power of dividends can sometimes be overlooked by investors – particularly by those new to investing – who can sometimes be more focused on the potential for share price appreciation.
Dividend payments make a huge difference in returns, particularly when it comes to Australian listed companies because they pay more of their profits as dividends than just about any other market.
Hugh Dive of Atlas Funds Management says investors should not underappreciate the powerful impact of dividends and franking credits.Credit: Louise Kennerley
The largest 200 companies listed on the Australian Securities Exchange will pay about $85 billion in dividends over the next 12 months.
While the share prices of those same companies rose 43 per cent over the past 10 years, if dividends were reinvested to buy more shares, the overall return would jump to 116 per cent.
Commonwealth Bank’s (CBA) share price has risen 58 per cent over the past 10 years. After accounting for dividends, that becomes 112 per cent, figures from Atlas Funds Management show. It gets even better after accounting for the impact of franking credits, with the return increasing to 135 per cent.
Franking credits compensate shareholders for the tax that companies pay on profits. Not all companies pay franked dividends or pay dividends that are 100 per cent franked.
During times of market downturns, the falls in the share prices of the big dividend payers, such as CBA, are cushioned.
Fortescue has produced a return, including dividends and franking credits, of 779 per cent, the best return among the largest 20 companies over 10 years. However, rather than a steady stream of dividends, the company paid some large franked special dividends during the 10-year period.
As mining companies are dependent on commodity prices, their dividends are less reliable than those of big banks.
In the latest reporting season, BHP, which has produced a return of 155 per cent over 10 years, reported a fall in profit for the six months to December 31 last year compared to the previous corresponding half due to writedowns, even though revenue was higher.
The mining giant will pay an interim fully franked dividend that is 20 per cent lower than the dividend it paid 12 months earlier.
Meanwhile, though CBA’s profit result for the same period was lower than the prior corresponding half, the bank will pay a fully franked interim dividend that is 2 per cent higher than the year prior.
“You hear some people say that you are better off investing in global markets that have better returns and that, in comparison, the Australian market can appear a little unexciting,” says Hugh Dive, the chief investment officer at Atlas Funds Management.
“That ignores the powerful impact of dividends and franking credits with Australian companies consistently paying higher distributions.”
While the cash dividend yield on the United States’ S&P 500 is 1.28 per cent, for the local S&P/ASX200 it is about 4 per cent.
During times of market downturns, the falls in the share prices of the big dividend payers, such as CBA, are cushioned.
Dive likens dividends to an ‘airbag’ to the share price, as investors see a chance to buy the dip as they value the tax-effective dividends they produce, which tends to put a floor on the share price and prevent it from dropping too low.
The returns of Australian listed health tech companies, like Cochlear (545 per cent) and CSL (328 per cent), have come mostly through share price appreciation. They can certainly deserve a place in a well-diversified portfolio of a patient investor, Dive says.
While the power of dividends should not be overlooked, investors need to be careful not to fall foul of the “dividend trap”.
Sometimes, a company’s shares are trading on a high dividend yield because the share price has fallen so much. Some companies whose shares can be bought on big trailing dividend yields have business models that are challenged or are expected to deliver significantly lower profits and dividends in future years, Dive says.
- Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.
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