Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 251

Three reasons why current dividends matter

Recent headlines on dividends have been primarily focused on the proposed removal of some of the more favourable tax treatments if the Labor Party secures government. While franking credits certainly enhance the attraction of dividends for many investors, we believe there are other reasons why the dividend income earned from an equity portfolio is an important element to consider when constructing an equity portfolio.

There are three key reasons why dividends have always been an important component for investors:

1. Dividends are a more reliable source of return than capital gains

Returns from equities come from two sources – capital appreciation and the dividends received from the shares held.

The returns from the S&P/ASX300 of these two components over the last 20 and 40 years are:

Source: Calculated using IRESS data indices

The importance of the dividend component of an Australian equity portfolio to investors is evident: around half of the returns of the S&P/ASX300 in the last 20 and 40 years have come from dividends.

2. The level of dividends received is not affected by the level of the sharemarket

While the level of capital returns from an equity portfolio over any defined period generally depends on the movement in the sharemarket, the level of dividends is dependent on the performance of the underlying companies, not the movement in share prices.

The level of dividends and the dividend payout ratio of any company is set by the Board of the company. It is generally a reflection of the overall profitability of a company and is independent on the level of its share price.

An investor’s level of dividends from a diversified portfolio – if made up of quality companies with the right attributes – should not vary greatly from year to year and is irrelevant to what is happening on the overall sharemarket, including during price falls.

Over the past 20 years, for the S&P/ASX300, the volatility of capital returns was 12.6% and dividend volatility was 1.0%.

Chart 1: volatility of returns of capital and income of the S&P/ASX 300 over 20 years

Source: IML, S&PASX300 31/03/1998 – 31/03/2018

Chart 1 shows that the volatility of capital returns has been high over the last 20 years, which is not surprising perhaps as it contains periods such as the tech boom and bust, the GFC, and the Eurozone crisis. However, the volatility of the dividends for an investor in the S&P/ASX300 has been very low.

This trend is true also on a year on year basis. Chart 2 shows the breakdown of the level of returns from the S&P/ASX300. The level of dividends paid (the orange bar) has been much less volatile than the level of capital returns (the blue bar) over the last 20 years.

Chart 2: Returns to shareholders over the past 20 years

Click to enlarge. Source: IML and Morningstar Direct, S&P/ASX 300 01/01/1998 – 31/12/2017

Regardless of share price performance, the vast majority of companies in the S&P/ASX300 continue to pay dividends which to some extent compensates sharemarket investors for a share price often beholden to the whims of the market.

3. The dividend yield on stocks can act as a ‘safety net’

The movement in the sharemarket – particularly over shorter periods of 6 to 12 months - is often driven by market sentiment. This in itself is affected by predictions as to the future level of economic activity, inflation, and interest rates, as well as perceptions of geopolitical stability.

Often, minor events in hindsight from an economic standpoint can cause the mood of investors to sour markedly and lead to large declines in the sharemarket. For example, Iraq’s invasion of Kuwait in 1991 led to gloomy predictions about an impending global recession by many market analysts and economists.

A perceived crisis can cause many investors to panic, and the prices of shares can fall heavily initially, often indiscriminately and independent of their quality. Once the panic subsides, companies with sustainable earnings that can support a healthy dividend stream are often the shares that can recover the quickest.

The reason for this is fairly obvious. Rational long-term investors are always attracted to companies that pay a healthy dividend from a sustainable earnings stream. Once shares in quality companies fall to a level where the dividend yield is attractive, long-term investors buy these shares to ‘lock in’ attractive dividend yields, despite a volatile sharemarket.

Conclusion

Dividends provide sharemarket investors with a consistent part of their total return and can also act as a ‘safety net’ in down markets.

While the proposed changes to the tax-effective treatment of dividends in Australia via franking credits is potentially a negative development, dividends will remain an important factor when investing in the sharemarket. They will continue to provide investors with a relatively stable part of returns through the delivery of real cash flow, irrespective of the market cycle.

Fundamentals should remain crucial to deciding which companies ought to be included in a portfolio - mainly the quality and transparency of the earnings, cash flow generation, gearing levels, or balance sheet strength – which ultimately determines the level of dividends.

 

Anton Tagliaferro is Investment Director at Investors Mutual Limited. This information is general in nature and has been prepared without taking into account of the objectives, financial situation, or needs of any investor.

 


 

Leave a Comment:

RELATED ARTICLES

Doubling down on dividends

The best income-generating assets for your portfolio

Why the ASX 200 has gone nowhere in 16 years

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

The greatest investor you’ve never heard of

Jim Simons has achieved breathtaking returns of 62% p.a. over 33 years, a track record like no other, yet he remains little known to the public. Here’s how he’s done it, and the lessons that can be applied to our own investing.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Welcome to Firstlinks Edition 552 with weekend update

Being rich is having a high-paying job and accumulating fancy houses and cars, while being wealthy is owning assets that provide passive income, as well as freedom and flexibility. Knowing the difference can reframe your life.

  • 21 March 2024

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

Latest Updates

Shares

20 US stocks to buy and hold forever

Recently, I compiled a list of ASX stocks that you could buy and hold forever. Here’s a follow-up list of US stocks that you could own indefinitely, including well-known names like Microsoft, as well as lesser-known gems.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Property

Baby Boomer housing needs

Baby boomers will account for a third of population growth between 2024 and 2029, making this generation the biggest age-related growth sector over this period. They will shape the housing market with their unique preferences.

SMSF strategies

Meg on SMSFs: When the first member of a couple dies

The surviving spouse has a lot to think about when a member of an SMSF dies. While it pays to understand the options quickly, often they’re best served by moving a little more slowly before making final decisions.

Shares

Small caps are compelling but not for the reasons you might think...

Your author prematurely advocated investing in small caps almost 12 months ago. Since then, the investment landscape has changed, and there are even more reasons to believe small caps are likely to outperform going forward.

Taxation

The mixed fortunes of tax reform in Australia, part 2

Since Federation, reforms to our tax system have proven difficult. Yet they're too important to leave in the too-hard basket, and here's a look at the key ingredients that make a tax reform exercise work, or not.

Investment strategies

8 ways that AI will impact how we invest

AI is affecting ever expanding fields of human activity, and the way we invest is no exception. Here's how investors, advisors and investment managers can better prepare to manage the opportunities and risks that come with AI.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.