If ever there were a sign that Australian investors are obsessed with dividends, this is it: Cochlear (ASX: COH) posted record sales for 2015 and a 56% rise in net profit – not to mention management expectations for 14% growth in 2016 – yet the share price fell 10% following the announcement. Why? Cochlear’s board reduced the full-year dividend by 25%.
Of course, in Cochelar's case several other factors were also at play and investor expectations got ahead of themselves, but a broader question remains: Why has everyone gone gaga for dividends?
Franking credits make dividends particularly tax friendly in Australia. But imputation has been around for nearly 30 years – it’s not the full story.
We suspect the army of retirees now managing their own superannuation are to blame. The number of self-managed super funds has increased from roughly 100,000 in 1999 to over 500,000 today.
Retirees are, rightfully, looking to derive an income from their assets and so seek out stable high-yield securities. With interest rates at record lows, however, this yield-seeking behaviour has become extreme and the increasing pressure on boards to keep raising dividends is starting to cause problems.
For one thing, blind yield seeking has pushed up the share prices of stable dividend payers to some very tenuous valuations. Take toll-road operator Transurban (ASX:TCL), for example: with an enterprise value to EBITDA ratio of 30, it’s now trading at a 50% premium to its 10-year average. At these valuations, investors are taking on a good deal of hidden capital risk in exchange for yield.
It‘s become next to impossible to find anything undervalued that pays a stable dividend. And if you do find something with a high yield, you can bet your boots there’s a decent risk that that dividend will be cut sometime soon due to a forecast decline in earnings.
Another problem is that boards are under increasing pressure from investors to keep raising dividends, whether or not this is in the company’s best long-term interest. The share market is increasingly viewed as a giant ATM, rather than a mechanism to provide companies with capital for investment. As fellow analyst Gaurav Sodhi said to me the other day: ‘investors are confusing bank shares with bank accounts’.
While boards do all they can to increase dividends, Australia faces a shortage of capital investment. Companies simply aren’t reinvesting in their businesses – non-mining business investment has fallen from 14% of GDP in 2007 to around 10% today, it’s lowest level since Australia’s last recession in 1991.
Ultimately, this starves investors of future growth and undermines the long-term competitiveness of Australian companies against countries that reinvest more heavily in innovation, such as the USA.
Many argue that when companies do retain a significant portion of earnings, management just wastes the money. We’ll be the first to tell you this is sometimes the case, and we applaud shareholder-friendly management.
But maybe Australia’s company directors have become a little too shareholder friendly. Where there’s opportunity to reinvest capital in the business at decent rates of return – as in the case of Cochlear – upsetting a few yield-hungry investors is a price worth paying for future growth.
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