Well, how about this. Aussie companies will pay out a cool total of $54 billion worth of dividends in the 2013 financial year. But Goldman Sachs put everyone on notice this week by pointing out that payout levels are nearing their historic peak. The great dividend rally of the last year or more might be coming to a natural limit.
According to the vampire squid investment bank, the last time Aussie companies were dishing out near this percentage of profit was back in the days of Australia’s last recession in 1992.
The vibe is that boards are reluctant to invest in their own businesses in the face of a weak economy. And investors are happy to get their hands on the cash thanks to low interest rates. That’s all fair enough.
Of course, if you’re interested in income, you do have to make sure you’re buying good businesses, not just a fancy yield…
The Choice Every Company Has to Make
For the record, here’s an idea of how strong the dividend rally has been. Check out the chart for the iShares S&P/ASX High Dividend Fund over the last half year:
Source: Yahoo Finance
Around a 30% return from a reasonably conservative ETF is pretty good going.
But in the end companies can only payout so much. They need to keep some money to grow their business.
Take Woolworths (ASX: WOW), for example. Tony Boyd pointed out in the Australian Financial Review this week that CEO Grant O’Brien is turning the company into a tech investment story:
‘For the first time, the money earmarked for the Woolworths supply chain’s information technology, multi-option strategy and stay-in-business projects will exceed refurbishment… The combination of a cutting edge point-of sale-system, data analytics, loyalty cards and core systems that connect with suppliers should put Woolworths ahead of competitors.‘
Woolworths doesn’t want to lose market share to international retailers with tech marketing savvy who could use local distributors to shift their product. The pay off for investors is that this investment in tech and systems now should show up as capital gains down the track. There’s no guarantee, of course. You have to trust management to turn retained earnings into market value.
Over at Australian Small-Cap Investigator, this is the attitude Kris Sayce has been hunting with success, but at the other end of the market; small caps. He calls these type of companies ‘Turbocaps’. You can see why here.
Travel agent Flight Centre (ASX: FLT) is no small cap stock, but it’s a pretty handy guide for the kind of business to look out for. It managed to grow its profit by 20% and its dividend by 28% in the last financial year. The share price is at an all time high and up almost 100% for the year.
But don’t be led into thinking a rising dividend is an automatic sign of a healthy business. Unfortunately, not all companies are doing it with rising earnings and profits like Flight Centre. That’s not sustainable in the long run and will eventually show up in a weaker share price.
Our value investing expert Greg Canavan recently explained why over at The Daily Reckoning:
‘If companies don’t reinvest then it makes it hard to generate sustainable earnings growth. Without earnings growth you get little to no growth in intrinsic value. So even though reinvested dividends might push up share prices, the intrinsic value of the company isn’t increasing, and it may even be falling. A higher share price with little to no earnings growth simply reflects a stock getting more expensive.
‘We’re generalising here to make a point. The point is that higher dividend payout ratios might sound good to shareholders thirsting for income, but it undermines a company’s long term intrinsic value by having the board make capital management decisions to satisfy the short term demands of investors rather than the long term demands of the business.‘
Greg’s take is the market rally will hit a wall and turn down.
A Different View
Of course, all that only applies if you’re actually in the market. One who isn’t is the latest editor to join our team, Vern Gowdie. He’s 100% cash for now.
Vern is expecting a major correction in the US stock market, which in turn he expects will take down the stock market here. You can see why he’s expecting such a fall in a special report released later this afternoon.
But Vern’s mission is not just to analyse the stock market. He’s looking at guiding subscribers with his near 30 years in financial planning. He’ll cover such topics as how to establish a model portfolio, cultivating the right family wealth culture, how to avoid the common pitfalls that destroy your capital and plenty more topics that impact your money.
After all, there’s a lot more to building and keeping wealth than just dividends.
Editor, Money Weekend
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