Importance of Dividends
Dividends are generally being paid by higher quality companies which have good cash flow, occupy a strong position in their relative industries, and provide stable returns in times of volatility. Additionally, they are attractive to long-term investors who have the capacity to ride out volatility periods as during a downturn they balance the investors’ portfolio by reducing selling pressure.
In a stock market, high dividend paying stocks are considered as dividend growth stocks and investors seek to maintain their profit portfolios with the help of balancing growth stocks along with other stocks. However, looking from the other side the story may be a bit different. According to a global equity strategist at Citi Research, investing in companies that pay higher dividends despite falling earnings poses a risk as these dividends are not sufficiently covered by profits earned over a period of time.
Latest Global Statistics
In 2016 (year-to-date), the Dow Jones US Dividend Select Index (INDEXDJX:DJDVP) surged by more than 8.54% while the Dow Jones Global Select Dividend Index (INDEXDJX:DJGSD) surged 2.45% compared to negative returns of many equity markets. Within the S&P 500, the top 100 highest yielding stocks have gained 3% this year while those with no dividends have eroded more than 4%.
INDEXDJX:DJDVP Daily Chart (Source: Thomson Reuters)
In the past one year, the world’s listed companies have paid out more than half of their profits in the form of dividends pointing to an unusual situation that indicates widespread economic weakness. As per data from Citi, in two years the proportion of profits paid out as dividends by companies within the MSCI World index soared to 51% from 43% higher than the long-run median of 46%. According to J.P. Morgan calculations, annual income available from the Barcap Multiverse Bond index is 1.7%, a record low level. Also, the firm calculates dividend yield on global stocks as 2.7% and rising to 3.4% with the inclusion of net share buybacks.
According to a recent report from Chicago-based Henderson Global Investors, in the year 2015 global dividends increased by 9.9% to $1.15 trillion with most of the growth dented by strengthening U.S. dollar (reduction of almost $104 billion). Looking ahead to 2016, dividend forecast for the year is narrowed by $10 billion to $1.17 trillion led by cuts in the commodities sector. As a global trend, U.S. and Commonwealth countries pay the highest dividends. Meanwhile, Japan recorded a 19% increase in payouts in 2015 while China posted its first annual decline of 1.5% in dividends.
Global Shift towards High Dividend Payouts
With the past few years highlighting unsatisfactory dividend yields, companies have shifted their focus on being high dividend paying in order to return the maximum possible to shareholders. Notably, energy companies which have been hit significantly by falling oil prices are the ones whose dividends exceeded the profits of these companies. The global trend in recent times reflects that income focussed investment funds have gained popularity as investors are looking at higher return to shareholders.
In 2015, reforms to the Tokyo Stock Exchange’s corporate governance code were also followed by rising dividends. On the other hand, in February 2016 Larry Fink, chief executive of asset manager BlackRock, wrote to chief executives of U.S. companies highlighting the growing proportion of profits paid out to investors and urging each to lay out a strategic framework for long-term value creation.
Australian stocks and dividend analysis
The Australian stock market has rebounded from its February lows and has gained about 9.8% since March 02, 2016 as of May 30, 2016. This indicates that the market is only slightly lower from its 2015 high levels. The Australian companies have paved an attractive pathway for investors while boosting stock prices which is through pushing dividend payout ratio higher. In the past, the companies that paid 60% to 70% of their profits had now increased the ratio to 80% to 90%.
However, there are a few risks attached to this strategy which include benefits to the companies in the short term by diverting the funds from long term reinvesting for future to the shareholders. Also, if the economic growth softens, these companies may not be able to increase payout ratios higher than 90% level. A threat to the Australian companies is higher as according to data compiled by Bloomberg wherein payout ratio exceeds 100% for these companies as with every $100 of profit generated the payout stands at $118 in dividends.
Reserve Bank of Australia recently commented that these high dividend payouts maybe living on borrowed time which in the longer run may pose a threat to the economy. In 2015, Australian-domiciled listed companies announced dividend payments of $78 billion which accounted for 81% of the underlying earnings of these companies and 4.8% of their capitalization as of June 2015.
Ten ASX Companies with High Dividend Yields (Source: Thomson Reuters)
U.S. Earnings Quarter and Dividends
The 2016 first quarter of earnings season for U.S. companies has revealed some softness for the economy since 2009. However, analysis reveal that this would be the best quarter on record for dividend payments. As per a Goldman Sachs report, with the S&P 500 earnings per share are expected to decline by 1% year-over-year and dividends per share to rise by 4.6%. Furthermore, on a rolling four-quarter basis, dividends per share grew by 7.5% to $43.88, establishing a record level. In 2016, the strongest sectors of the S&P 500 are those which have offered relatively higher dividends and not slashed payout ratios for the past five years.
In the first quarter of 2016, for the entire U.S. stock market, 919 companies increased their dividends, almost 8% less than the same period a year ago, as per a report by S&P Global Market Intelligence. Meanwhile, for the last four quarters, 2,733 companies increased their dividends, 15.3% fewer than in the previous four-quarter period. Interestingly, the dividend yield on S&P 500 was higher than the yield on the U.S. Treasury 10-year note. According to data from FactSet, in the past 5 years the 10-year Treasury note was yielding 1.78% as compared with an average dividend yield of 1.96% for S&P 500 stocks.
All in all, a very prudent approach should be taken at this time to invest in companies which should entail looking at company fundamentals as well as dividend pay-out scenarios.
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