Why We Like Dividends

Introduction

Dividends can provide a degree of security in volatile times and are likely to provide a relatively stable and attractive source of income combined with 'earnings growth' giving a relatively high proportion of returns going forward.

Up until the 1950s most share investors were long term investors who bought stocks for their dividend income. This changed in the 1960s when investors started to shift focus to capital growth. However, with volatility seen of late, and an increased focus on investment income as baby boomers retire, interest in dividends has been on the rise.

Australian companies generally pay out a high proportion of earnings as dividends. This is on average 75% since the late 1980s. Banks, telcos, consumer stocks and utilities are the big dividend payers. By contrast in the major global markets dividend payout ratios range from 31% in Japan to 49% in the UK.

Dividends do matter

Dividends matter in terms of returns from shares. It has been found that higher dividend pay outs have lead to higher earnings growth. Higher growth in company profits contributes to higher returns from shares over the long term.

The bottom line is that strong dividend pay outs are more likely to be consistent with strong earnings growth. As can be seen below, dividends move roughly in line with earnings. For an investor this means the flow of dividend income is relatively consistent.

Source: Thomson Reuters, AMP Capital

Dividend yields provide security during uncertain times. Dividends provide a stable contribution to the total return from shares over time. Of the total return from Australian shares since 1900, just over half has been from dividends.

It is expected that investor demand for stocks paying decent dividends will be supported over the years ahead as more baby boomers retire and focus on income generation. Dividends will comprise a much higher proportion of total equity returns than was the case in the 1980s and 1990s globally and in Australian shares up until 2007.

Finally, dividends provide good income. The Australian sharemarket is currently providing around 5.7% (incl franking credit).

Dividend income growth

The next chart illustrates the power of investing for dividend income compared to income from bank term deposits. It compares initial $100,000 investments in Australian shares and one year term deposits in December 1979. The term deposit would still be worth $100,000 and shows interest paid at $4,150 in interest (4.15%). By contrast the $100,000 invested in shares would have grown to $1,054,000 and have paid $45,000 in dividends (4.26%). This would equate to around $59,650 with franking credits (5.65%). The reason for the difference is over time an investment in shares tends to rise in value, whereas an investment in term deposits is fixed.

Source: RBA, Bloomberg, AMP Capital