Death by Dividend

Death by Dividend

There’s a dividend bonanza underway. And it seems everyone on the ASX is caught up in the rush.

Woodside increased its dividend, despite a 41% drop in profits. Wesfarmers increased its by 10%, quintessential growth stock Fortescue Metals maintained its 10 cent dividend and Suncorp raised its dividend 40%, just to name a few.

Perpetual says dividends across the ASX200 over the last 12 months are up 6.7%. But here’s the problem. That’s slightly more than earnings which, are up 6.2%.

So companies are paying out an increasing share of profits. And that means they’re reinvesting less into their operations. With less reinvestment comes less future profit. And less economic growth. See the problem?

Back when The Money for Life Letter first launched, we predicted the return of dividend domination. Years ago, investors considered dividends the key to stock market returns. Today, only academics and researchers pay attention to the evidence that they do.

But investors will only wait so long for the capital gains they are continuously promised, but don’t happen. And boards have responded by upping their dividends to make their shares more attractive and bid up the price.

But that’s a dangerous game. Investors don’t like dividend cuts one bit. And paying out increasing shares of your profit can make it difficult to generate the kind of growth that creates cash flow for your future dividends. It’s like a high jump competition. How high can your dividend go before investors think you’ll break your neck on the way down?

Kris Sayce came up with a unique way of playing the trend last year. He explained how this dividend boom could lead to the ultimate combination – dividends and capital gains – in the small cap sector. And things have played out nicely for his tips since. One just raised its dividend 60%!

Finance theory explains the life cycle of a company tends to end with an increasing amount of profit paid out. This signals that the company has matured and early investors are finally going to collect their gains in the form of a steady income stream. Without dividends at some point, what’s the purpose of investing in shares? What’s their value? If they never pay out cash, nobody would buy them. 

The problem is, even growth stocks are paying out profits at the moment. Not to mention Kris’ small caps. So what happens when the bulk of Aussie companies are caught up in the trend? Where do paid out profits and a lack of reinvestment leave the Australian economy?

According to the Australian Financial Review, we’re creating a low wage ‘Downton Abbey economy’. We don’t watch the show, but the reference supposedly means that the service sector is growing as the manufacturing economy declines. Services tend to require a lot less capital investment, but provide lower wages and part time jobs. This is unambiguously a bad thing to economists.

But many Australians would probably be excited at the thought of turning their favourite TV show into reality TV starring them. We read somewhere that the demand for butlers is on the rise, if that’s your thing. There’s also a clown shortage in the US, which is more our gig.

It’s not all morbidly amusing though. The fallout of leaving industrial companies is rearing its ugly head in the rest of the economy. Scrap metal companies, an excellent measure of industrial health, are winding down operations, leaving Australia or dying ugly deaths. CMA Corporation went into administration, Arrium reduced its scrap business operations and Transpacific Industries is expecting trouble in the scrap market.

One problem with a services sector economy is your trade balance. A lack of manufacturing tends to reduce exports. And that poses a risk to the currency. But Australia’s key exports – agriculture and resources – are doing just fine.

As an aside, Greece just posted its first current account surplus since records began in 1948. Tourism flooded the place after it cut prices. What a surprise! Might that work in the rest of the economy too?

Anyway, many economists point out that becoming a services based economy is just a sign of maturity. There’s that word again – maturity. How’s the mining boom going? It’s maturing. The population is maturing too.

Even Australia’s mighty property sector is changing to deal with all this maturity. In Sydney, developers are converting office towers into residential apartments at an increasing pace. The property version of productive assets are being replaced by consumption goods. In the CBD alone, they’re remodelling 10 buildings. Surely this isn’t what economists meant when they said a housing construction boom would replace the mining boom. Developers seem to be taking things a little too literally.

What’s left of commercial property isn’t exactly being bought and used by upcoming Australian companies blazing a trail of creative destruction. Local councils have been ‘investing’ in commercial property at an alarming rate. In Melbourne, they bought up $54 million dollars worth last year. Some of it is used for staff. Some of it is rented out. But much of it is sitting empty according to The Age.

But is maturity just a nice name for something bad? The fact that the end draws near?

Speaking of bad endings, what’s going on in safe haven gold? It’s up around 10% for the year.

As always, everyone knows why the precious metal is up. But nobody can agree on it. A looming credit crisis in China, concerns for US economic growth and more QE, and a change in Indian government restrictions on imports are all on the list of ‘reasons’. In case you’re planning on smuggling gold into India, the premium charged by the black market just surged 24%.

Our theory is much simpler. Demand is outweighing supply. But in the gold market, neither of the two is based on free market forces. Between them, banks, central banks and futures markets distort the gold price to the point of making it meaningless. And until there is a crisis which stops the manipulation, the gold price won’t be meaningful.

The good news for gold investors is that you own gold specifically for such a crisis. Until it happens, don’t get emotionally involved with the gold price.


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Nick Hubble

Nick Hubble

Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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3 Comments on "Death by Dividend"

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slewie the pi-rat
there has been quite a bit of controversy about gold supply and demand since the World Gold Council published its recent 2012/13 Y-o-Y ‘sources and uses’ summary, earlier this month. this is the same as a cash flow analysis, but for gold, ok? gold flow analysis. now, i have said, from time to time, myself: “be a bit wary of the WGC,” rather than parrot everything from it as if there could be no other source of auric veritas. for example, sometimes they rely heavily on banksters for data… here is the controversial summary: the WGC had to deal… Read more »

The 1890’s were chockers with big dividend payers. Trevor Kennedy did a good job listing a lot of them and their fates.

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