Given the ongoing market volatility with cyclical impacts from the commodity prices, many Australian investors resort to stocks that pay decent dividends on a consistent basis. Key reasons for this addiction for dividend-paying stocks is better understood from the following:

Avenue of Income Stream: The investors want to build long term wealth and for this investors accumulate stocks of well managed companies with sustainable business that give them a steady, growing stream of dividends. Dividends are paid from the earnings or the profit added to the reserves. Many Australian companies give better proportion of the earnings as dividends to the shareholders. On an average, dividend payout ratios are generally healthier in Australia as compared to major global market. The investor demands for stocks paying decent dividends to get the income stream are supported over the years ahead as more baby boomers retire and then they focus on the income generation. They are less risk averse and gain patience while investing in the stock.

Linked to Interest rates and Tax benefits: First of all, the low interest rate environment in Australia kicks off well with the dividend stocks and many investors thus have started eying for such stocks in today’s scenario. Australian companies can also attach franking credits to the dividends to indicate the amount of tax paid by the companies already thus saving investors from paying taxes, which averts double taxation. Double taxation primarily means calculation of tax twice, once in the hands of companies and again in the hands of investors. The corporates get encouraged to give decent dividends to shareholders as opposed to irrationally hoarding earnings. The Interest on corporate debt never suffered from double taxation as it is paid out of pre-tax corporate earnings. And all such concessions encourage savings in the face of Australia’s relatively high marginal tax rates.

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Australia dividends and earnings (Source: AMP, Thomson Reuters)

Reflect Corporate Confidence: The high dividend payouts indicate higher corporate confidence about future earnings. The high dividend payouts are generally a positive sign as they indicate earnings are backed by cash flow. The companies give dividends from the retained earnings that is when the profits are ploughed back to the reserves and show the visibility of the future earnings. The stock market also reacts positively to the company which has strong earnings visibility and shows corporate confidence.

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Provide Sense of Security: The decent dividend yields provide security during uncertain times, that is when the market is continuously falling for a longer time, like when there is huge fall in the prices as seen recently in the case of Brexit. The dividends provide a stable contribution to the total return from shares over time, compared to the annual volatility in capital gains. Dividends are good for investors as decent dividends reflect for the good earnings growth, they provide a degree of security in uncertain and volatile times, they are likely to comprise a relatively high proportion of returns going forward and they provide a relatively stable and attractive source of income. The investors trend to carefully watch out for ‘defensive’ ASX stocks. In such scenario, we have seen in the past that stocks of the big four banks, including Australia and New Zealand Banking Group and National Australia Bank, along with companies like Woolworths Limited are considered as source of high yields and income.

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Comparison between deposits and shares (Source: RBA, Bloomberg, AMP Capital)

Many-a-times better than Bank Deposits: Dividend can give better returns than the bank deposits. The investing to get the dividend income can be compared to the investing for income from bank term deposits. Some companies have given steady income to investors as they have consistently given back a significant chunk of their net profits like 25% of the net profit to shareholders in the form of dividends while some bank deposits have given the return of 5%.

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