Investors have faced a low-growth environment with low dividend yield for some time now – and this does not appear to be changing anytime soon.
Global economic activity is slowing notably, reflecting a combination of factors affecting the major economies.
Historically investors who look for income in the form of interest payments – also called yield, have looked to fixed income (bonds) and cash (bank deposits) in a normal low growth environment.
But with record low interest rates these returns as a measure over inflation have proven harder to find. One of the strategies investors have been forced to look at is to invest into the share market for dividend yield, which is yield paid in the form of a dividend.
This strategy has pushed money into Australia’s traditionally high dividend-paying stocks. It has also driven by the benefit of our franking credit system. This has, in-turn, been one of the underlying reasons why our share market has risen strongly, since the Global Financial Crisis in 2008.
The share market can be a generator of income, in the form of annual dividends from companies. Not all companies pay a dividend, and it is not compulsory.
However, Australian companies pay out a high proportion of earnings as dividends, as measured by the dividend payout ratio. Listed companies have, on average, paid out 65% of their earnings in the form of dividends from 1917 to today.
Over time, dividends can provide a contribution to the total return earned from shares. Just under half of the long-term return from holding Australian shares comes from the dividend component. (Looking at the market’s “total return” index, the S&P/ASX 200 Accumulation Index. )
Over the last 10 years to June 2019, the S&P/ASX 200 Accumulation Index has generated a return of 10.0% a year, versus 5.3% a year for the S&P/ASX 200 price index. This means dividends are responsible for 4.7% a year, or just under 50% of the total return.
For long-term investors who receive the dividend component of the total return, this can be less volatile than the capital growth component.
As such, companies tend to ‘smooth’ the payment of dividends through the use of available cash flows. That is independent to the changes in the company’s share price from time to time.
However, there are several aspects of the stocks-for-yield strategy that make it one that should be constantly monitored.
First, a stock market dividend yield cannot be considered as certain. Why? Because the dividend amount is at the discretion of the company, each reporting period.
Second, the risk of share-price capital-loss, while holding shares for yield, is always present.
For active stock-pickers with a value orientation, opportunities might look like they are thin on the ground. But it’s important to remember they are usually present. It might just require a harder look.
The key to this process is to think of the businesses represented by the stocks on the stock exchange.
Short-term market volatility is often driven by macro-economic or geo-political events. But, the underlying fundamentals of businesses are what essentially drive the returns from the stock market, through the “duration effect.” This is a company’s ability to grow its value over time through the compounding of its cash flow.
From time to time, the stock market will under-value some businesses, and over-value others.
There is little correlation between the performance of individual stock-exchange-listed businesses and economic growth. Each company has specific factors that drive its revenue and profitability.
There are always stocks out-performing the market, and certainly out-performing the economy.
Whether you want to back these stocks for short-term trading opportunities, or longer-term investment, is up to you.
But they are always there to be found.