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Dividend darlings: future brightens for yield stocks

30th March 2017
Dividend darlings: future brightens for yield stocks
Julia Lee
Equities Analyst
Bell Direct

Interim reporting season highlights best income plays.

Over the long term, much of the returns from the Australian sharemarket have been through dividends. When reinvested, the power of compounding can see returns snowball over time.

Since 2000, the Australian sharemarket has returned 84 per cent and with all dividends reinvested it would have been 280 per cent in that time.

This February half-year reporting season has again seen dividend returns grow. Of the 120 companies that had declared a dividend at the time of writing, the average increase in gross dividend has been 17 per cent; 67 per cent have increased dividends; 22 per cent have cut dividends; and 11 per cent have declared flat dividends.

Increasing dividends are related to increasing profit

Income investing is more than getting dividends. It is also about getting a sustainable dividend. Generally, companies that have increasing profits are more able and likelier to increase dividend payments over time.

Conversely, of the 26 companies that cut dividends this reporting season, a few were related to a change in franking credits, but the majority were because of a fall in profitability.

Often if companies strike a rough patch, they will start to cut or cancel dividends. A forecast of negative profit growth can be a precursor to a cut in the dividend.

Also, be wary of companies that increase their dividends without the corresponding increase in profits. They may be attempting to keep their share price higher but this will not be sustainable.

Several companies reinstated paying dividends because of a turnaround in their business and some of the largest increases were from commodity companies that moved from reporting a loss to reporting a profit.

Some of the largest jumps in dividends were from mining-related companies, which enjoyed a big turnaround in fortunes because of rising commodity prices. Here are some of the biggest jumps in gross dividends this reporting season compared to the previous corresponding period:

  • Fortescue Metals (FMG) - 567 per cent.
  • Sims Metals (SGM) - 186 per cent.
  • Sandfire Resources (SFR) - 150 per cent.
  • Mineral Resources (MIN) - 147 per cent.
  • BHP Billiton (BHP) - 144 per cent.

More good news is that corporate earnings are collectively forecast to return to profit growth this financial year after two years of negative growth, which bodes well for increasing dividends.

Bank dividends

Traditionally, bank dividends have provided the stable dividend returns needed by income investors. Over the past 10 years, most of the return from banks has been through dividends and franking credits.

Commonwealth Bank (CBA) was the only big-four bank to report half-year numbers this reporting season, while ANZ and NAB provided a quarterly update. Since 2000, CBA has paid $44.56 per share in dividends and with franking credits included, this rises to $63.66. It is a lucrative way for investors to accumulate wealth over time.

In this interim reporting season, Commonwealth Bank reported $4.9 billion in cash net profit after tax and a $1.99 interim dividend. The dividend announced beat expectations. Importantly, the margin outlook looks better and with benign bad debts, the ability to sustain and raise dividends is looking positive.

Dividends from exchange-traded funds (ETFs)

For income investors who do not want to bother with stock selection, exchange-traded funds (ETFs) are growing in popularity. They give access to a portfolio without having to choose individual stocks and are traded on ASX just as you would trade shares.

Harvest (HVST)

The BetaShares Australian Dividend Harvester Fund has a 12-month distribution yield of 11.1 per cent, or 14.3 per cent on a gross yield basis. It pays distributions monthly and has a yield more than double the market. While you would not expect capital growth from a product like this, it can be useful for Self-Managed Superannuation Funds and retirees needing income. There is no minimum investment.

Looking at sectors over time

Certain Australian sectors have traditionally offered higher dividends: telecommunications, property and utilities. While the dividend yields offered have changed year to year, generally these sectors still offer yields higher than the market.

All in all, the Australian sharemarket can be one of the most tax-effective ways to generate income and the latest reporting season has again proved that increasing profits are correlated to rising dividends and, conversely, falling dividends are correlated to falling profits.

The great news for investors is that the outlook for dividends in 2017 is looking bright and for those who do not want to take the time to stock pick, there are a huge number of products catering for income investors that can be traded just as easily as shares.

This article was first published on ASX website.