An­nette Samp­son

It’s the to­tal re­turn from shares that mat­ters, not just the div­i­dend

Money Magazine Australia - - CONTENTS - An­nette Samp­son


Fi­nance 101 is clear cut. Div­i­dends are sim­ply a means through which com­pa­nies dis­trib­ute their prof­its back to their own­ers. So if a com­pany you own shares in is strug­gling to main­tain its profit or, heaven for­bid, los­ing money, its abil­ity to pay out div­i­dends is re­duced.

In Fe­bru­ary, Tel­stra cut its in­terim div­i­dend to 11 cents, from 15.5c the pre­vi­ous year, after a five-year fall in half-year prof­its. But here’s the thing: that div­i­dend cut was larger in per­cent­age terms than the profit fall be­cause Tel­stra also de­cided to change its div­i­dend pol­icy. For years it had paid most of its profit in div­i­dends. Now it is pay­ing out 70% to 90% and keep­ing a re­serve to rein­vest in the com­pany, par­tic­u­larly tak­ing the bat­tle to its com­peti­tors.

This is where it be­comes more com­plex. While fall­ing earn­ings can be a warn­ing sign that slower div­i­dend growth or a div­i­dend cut lies ahead, it is not the only fac­tor to take into ac­count.


If you are look­ing for in­come from your in­vest­ments, a key con­sid­er­a­tion is a com­pany’s div­i­dend pay­out ra­tio. This is the pro­por­tion of its prof­its that it pays out in div­i­dends. Thanks to the tax ben­e­fits of div­i­dend im­pu­ta­tion, Aus­tralian in­vestors have some­thing of a love af­fair with div­i­dends, and com­pa­nies are more in­clined to fund high div­i­dends to keep their share­hold­ers happy.

This means our pay­out ra­tio is typ­i­cally much higher than in many other mar­kets. In the US, for ex­am­ple, where in­vestors are more fo­cused on share price growth, a pay­out ra­tio of 50% is re­garded as nor­mal. While fig­ures dif­fer be­tween com­pa­nies and in­dus­tries, many Aus­tralian com­pa­nies pay out 70% to 80% or more.

So why does this mat­ter? First, if a com­pany is only pay­ing out 50% of its earn­ings in div­i­dends, it has more room to dip into re­serves to main­tain its div­i­dend if earn­ings were to take a hit. By con­trast, a com­pany with a high pay­out ra­tio doesn’t have that sort of wig­gle room. Com­pa­nies with very high pay­out ra­tios, such as Tel­stra un­til re­cently, could be forced to bor­row to main­tain div­i­dends dur­ing a bad pe­riod – clearly not a sus­tain­able strat­egy.

There is also an ar­gu­ment that com­pa­nies pay­ing out most of their earn­ings to share­hold­ers are do­ing so at the ex­pense of rein­vest­ing to grow the busi­ness. Ob­vi­ously, a more ma­ture com­pany will have less need to rein­vest than one that is grow­ing quickly, but some an­a­lysts see high pay­out ra­tios as an ad­mis­sion that man­age­ment is not fo­cused on fu­ture growth, and so is less likely to re­ward share­hold­ers with cap­i­tal gains.

While a solid div­i­dend in­come can feel re­as­sur­ing, it is the to­tal re­turn from shares that mat­ters. If a steady div­i­dend is more than off­set by a fall­ing share price, you’re still los­ing money.


When Tel­stra cut its div­i­dend, the mar­ket sent a strong mes­sage of dis­ap­proval via an im­me­di­ate 10% share price fall. But div­i­dend cuts are by no means rare events. In the wake of the GFC, the banks – the dar­lings of div­i­dend in­vestors – trimmed their div­i­dends to re­build their fi­nan­cial re­serves. Both Rio and BHP were forced to cut div­i­dends as the com­modi­ties boom came to an end. In the first week of this profit sea­son, lead­ing stocks such as AMP and Tab­corp also an­nounced lower div­i­dends.

Some an­a­lysts had been talk­ing up the risk of fur­ther div­i­dend cuts by the banks as a re­sult of the royal commission, though at the time of writ­ing only CBA had re­ported its re­sults. De­spite a drop in an­nual cash profit, CBA an­nounced a small div­i­dend rise.


For in­vestors, the key ques­tion is not whether a stock has a good div­i­dend yield but whether it has the abil­ity to sus­tain and grow that div­i­dend. Signs of an un­sus­tain­able div­i­dend in­clude a high pay­out ra­tio, a de­clin­ing earn­ings out­look (es­pe­cially if it in­di­cates a down­ward trend rather than just a short-term blip), and changes in com­pany pri­or­i­ties – such as a board that is be­com­ing more fo­cused on in­vest­ment.

* The au­thor owns shares in CBA and NAB.

An­nette Samp­son has writ­ten ex­ten­sively on per­sonal fi­nance. She was per­sonal fi­nance edi­tor with The Syd­ney Morn­ing Her­ald,a for­mer edi­tor of the Her­ald’s Money sec­tion and a colum­nist for The Age. She has writ­ten sev­eral books.

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