According to a report put out by Deutsche Bank a week ago, the Australian market is the second highest yielding market in the world, based on forecast yields over the next 12 months.
If you’re wondering who sits atop of the list, you don’t have to look too far. It’s just across the Tasman to our neighbours over in New Zealand. On a forward yield of 4.9%, the Kiwi market pips Australia by just 0.3%, with our market expected to yield 4.6% over the following year.
These sorts of numbers might not generate too much excitement among investors here. Especially with the Big Four banks, a perennial favourite among income investors, sitting on current yields of between 5–7%.
By comparison, the Japanese market is forecast to pay out a 2.5% yield, and the US a paltry 2.3%. You can see why Australia is seen very much as a yield market.
Everything is relative, though. With the Bank of Japan’s cash rate sitting at -0.1%, a 2.5% yield might not seem such a dud after all. That’s if investors can survive the volatility of the Nikkei.
The yields available locally have become a cornerstone for investors relying on their investments to bolster their income. While they’re double those available on the US market, it also reflects something structurally different about our two markets — growth versus income.
It’s become a well-worn complaint that finding true growth stocks on the ASX is a pretty tough task. If you take a look at the companies in the ASX 20, or even ASX 50 for that matter, you’ll be hard pressed to find stocks likely to run away to double-digit growth.
Most are mature businesses, paying out a high percentage of their profits to shareholders. A growth stock will instead hoard its cash to plough back into the business, or use it to finance further acquisitions.
Of course, those that specialise in the small to medium cap space will argue that there are always opportunities to invest in growth companies if you have a decent look around. However, the problem for those managing our $2 trillion-plus superannuation pool is trying to find a place to park all that money.
That sort of money isn’t going to squeeze its way into the smaller end of the market. That’s why it inevitably ends up chasing the same mega-cap stocks, like the banks, the supermarkets and Telstra [ASX:TLS], for example.
It’s also why shares now account for less than 50% of the asset allocation in superannuation funds. With little prospect of meaningful growth currently among the large caps, it’s predominantly the yield keeping the fund managers in there. Any decent kick to that, and we’ll most likely see share prices headed lower.
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In the 2015 financial year, the RBA reports that Australian companies paid out $78 billion in dividends to shareholders. That’s a whopping 40% increase over a five year period. The report states:
‘These (dividend) payments represented 81 per cent of these companies’ underlying earnings for the same period (the “payout ratio”) and 4.8 per cent of the market capitalisation of these companies as at end June 2015 (the “dividend yield”).’
At 81%, the next question is whether this payout ratio is sustainable. While much of the debate focuses on an increase in payouts over the last three to four years, the following table gives a broader view, going back 20 years.
Source: ASX, Morningstar and RBA
You can see that, over this 20 year period, the payout ratio has ranged from just under 60%, to around 75%. What is also apparent, though, is the acceleration in the size of the dividends from 2003 onwards.
If you take a look at the accompanying payout ratio over that same period, it is still well within its average range. And if you look closer into the period from 2002 to 2007, the size of the total distributions grew rapidly, despite a consistent drop in the payout ratio.
It’s this last part — from 2011 to 2015 — that gets all the attention. The increase in the payout ratio, from just under 60% in 2011 to 81% in 2015, looks like a pretty decent jump. However, it’s really a 5% jump above the upper band of the longer term trend.
But, of course, the real question is where to from here? The same report by the RBA notes that in terms of the total amount of dividends to be paid:
‘The top 10 dividend payers are expected to reduce dividend payments in 2015/16 for the first time since the global financial crisis, with the major miners having announced a shift away from progressive dividend policies.’
Note that this is the total across all 10 stocks, and not specifically for each company. If you take a look at the following table, it soon becomes apparent who the culprits are — the resource companies. Or more specifically, BHP [ASX:BHP] and Rio Tinto [ASX:RIO].
Source: Morningstar and RBA
You can see the massive drop-off in underlying profit (the red line) from the peak of the cycle in 2009–2010. Once the red line crossed over the blue line (the dividends), it was only a matter of time before these companies were forced to reduce their dividends.
What is also apparent from this table is the consistent spread between the profits and distributions of bank stocks. Not too many blips on that chart, when compared to the others.
The RBA report also states:
‘High-dividend-paying equities have outperformed the broader Australian index since 2011 on a total returns basis (share price plus dividends).’
That’s why you’ll continue to see money allocated to the big dividend payers, in particular the banks (over the mining stocks). What is also apparent, though, with earnings having peaked for this cycle, is that more money will sit on the sidelines in cash, as risk-averse investors wait for the next period of growth to commence.
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