Why Dividends Remain the Future for the ASX

Most people need little reminding of the importance of dividend investing. Few buy BHP [ASX:BHP] or Telstra [ASX:TLS] for their capital gains. Telstra’s share price is up only $3 a share since 2010. BHP is down $23 a share over the same period.

Capital gains aren’t the reason why they’re so popular with investors. Markets love these two because they pay an income. Investors sit on them to reap the benefits of generous dividend payouts.

As the income paying portion of an investment, dividends matter. In BHP’s case, its yield of 8.27% is the highest on the ASX. Whereas Telstra’s 5.86% is still at the upper end of the scale. These lavish yields are why both companies garner so much interest among investors.

They’re by no means the only two companies with progressive dividends. But they’re making headlines at the moment because they’re dividend darlings.

Both are now facing the threat of having to pare back high yields. And anytime talk of dividend cuts crops up, investors get nervous.

No dividends, no party

An article in this morning’s Australian Financial Review made a good point about dividends. It illustrated the importance of dividends to stock market investing. Without it, the ASX would’ve yielded little return during this past decade. The AFR reports:

Without dividends, it’s been slim pickings for the past 10 years. On Thursday, the major S&P500/ASX 200 index closed at 5234.6, just above the 5200 level that it breached for the first time in April 2006.

‘Since then it’s been a wild rise for the index — almost reaching 7000 in November 2007, before falling to 3145 in March 2009 — but there has been no capital gain. Include those dividends and sharemarket performance improves to a still paltry 4% per annum return.

It goes on to describe how this pattern applies across a range of time periods.

Since 2010, the ASX is up by 12%. Yet when we account for dividends, that figure rises to 41%. It’s the same story if we go back to 2005. The ASX index is up by 8%. But with dividend returns that’s raised to 68%. And if go back even further to 1995, the index is up by 143%. Yet that grows to 457% once we account for dividends.

Needless to say, dividends matter. Had you adjusted your portfolio to take advantage of them, the likelihood of strong returns would be much higher.

They’re so important that even the recent ASX rout had little impact. The AFR reports:

The 12% fall in stocks since this year’s peak in April has increased the forward yield to around 5%, and this improves once franking is included, making the local sharemarket more appealing than many offshore markets.

There’s no doubt the local market is one of the highest yield in the world, which means its shares pay high dividends relative to their total worth.

But, in theory, investors pile into equities for the growth, and over the past 10 years the Australian economy has performed well on some measures.

It might be better thinking about dividends in real terms. BHP alone hands out $9.2 billion in dividends every year. That’s a lot of money, even for a company the size of BHP. But the pressures on BHP’s revenues and profits may force it to lower payouts.

It’s a similar story for Telstra. The telco may need to deprive some of its dividend piggy bank to fund the ongoing NBN rollout.

Now, this doesn’t slap a sell recommendation on them. But both face the prospect of losing dividend hungry investors.

In Telstra’s case, investors may need to weigh up their priorities. The NBN program is an investment in growth potential. If investors are in it just for dividends, then it may force them to think twice about holding Telstra.

Slowing economy, slowing ASX?

The health of the economy plays an important role in the growth of the ASX as well. If the economy is growing, then it means that companies have scope for expansion. This works the other way too. As companies grow, they increase both production and consumption capacity. Both of these are vital for economic growth. And if an economy is faring well, it should reflect in the stock market too.

Yet what we’ve seen this past decade doesn’t quite match up with this theory. The Aussie economy has expanded, but the stock market hasn’t kept pace. In real terms, the economy has added $760 billion of GDP since 2005. But we haven’t seen this spill over onto the ASX.   The AFR explains:

At first glance it looks like the two are in sync. As measured by gross domestic product, the economy has grown from $1.27 trillion in 2006 to $1.6 trillion in 2015. During that time, the value of the benchmark index has risen from $1.1 trillion to $1.5 trillion.

‘But as John Abernethy, fund manager and founder of Clime Investment Management, points out, the measure of the sharemarket’s market cap includes all the value that has been generated from capital raisings and new floats.

Since 2006, the value has been unusually high at around $400 million. So while companies have delivered higher profits, they haven’t reported higher earnings per share’.

On top of this, economic growth is now slowing. Days of 3% GDP growth seem to be over. The economy is readjusting to a much lower rate of 2% a year.

At the same time, companies can’t rely on higher profits. As the economy cools, profits are either stagnating or falling. BHP’s profits plunged by $2.64 billion, or 86%, in the year to June.

A slowing economy will only limit company earning potential. And with bottom lines under pressure, the ASX will struggle to rise much above its present level. If it doesn’t decline first that is…

The reality of this makes progressive dividend policies even more important. Especially for the likes of BHP and Telstra which have a history of stable dividend payouts. Lowering them now would only send a negative message to investors. That typically happens when companies start lowering yields.

The big question is how they’ll fund these dividends amid weakening profits? Will it be through investment cut backs? Other cost cutting? Debt?

Dividends aren’t a pressing issue for either, as their balance sheets remain healthy. But for BHP it could become an ongoing concern. Unlike Telstra, BHP’s dividend policy is under threat from a weak commodity market. One that may not rebound even this decade. By comparison, Telstra’s potential cuts are an investment in growth. The NBN might be costly, but it has plenty of upside for Telstra once it’s fully operational.

Either way, dividends won’t lose their sheen anytime soon. In fact they’re set to become even more important than they already are. The ASX is likely to plod along on the back of slowing economic activity. That’s going to put pressure on corporate profits…and capital gains. And it stands to shine a bigger light on high yield stocks.

Mat Spasic,
Contributor, Markets and Money

PS: Amid falling energy prices, mining stocks haven’t fared well this year. But every investment, no matter how it looks, has an element of risk attached to it. As Markets and Money’s Bernd Struben would say, more risk equals…more risk. That doesn’t just apply to mining stocks. Every company you invest in comes with its own potential pitfalls.

Bernd’s written a free report, ‘Three Essential Rules to Boost Your Profits and Lower Your Risks’. In it, he shows you the golden rules for creating wealth in the stock market.

In particular, Bernd is keen to share the one investing rule that could save you thousands of dollars. You’ve no doubt heard of it, even if most investors ignore it. You’ll learn how this single investing rule can boost your portfolio profits.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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