Dividend a reason to invest

What a disappointing year it has been for investors, particularly for shareholders.

By InvestSMART · 14 Dec 2011

By InvestSMART ·
14 Dec 2011

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What a disappointing year it has been for investors, particularly for shareholders.

A recovery of sorts appeared to be under way when the market almost touched 5000 points, as measured by the S&P/ASX 200 index in April.

But in the second half of the year, trading was constrained to a range of between 4000 points and 4500 points. The market is about 5 per cent lower than where it started the year.

Any prospect of a sustained recovery in shares has likely been put off for even longer now that the euro zone is almost certainly in recession. That is bad news not just for those holding shares directly.

A poorly performing sharemarket leads to poorly performing superannuation funds because shares are the biggest investment of default funds, where most people have their super.

It is hard to see how share returns can improve next year when so much uncertainty surrounds the euro zone debt crisis. Speculation on recession in Europe could unsettle markets, even if the Europeans come up with a credible plan to get government debt under control.

Now the turmoil in Europe has been compounded by the spectre of recession, speculation over the consequences for global economic growth will intensify. The Australian sharemarket is regarded by global investors, such as pension funds, as a resources play, so lower global growth and commodities prices will force them to reduce their exposure. That is already happening to some extent because the high Australian dollar makes our shares expensive for foreign investors.

All this is swamping the relatively good news on economic growth and corporate profits.

Big companies such as Telstra and the banks are paying cash dividends of 6 per cent to 9 per cent, even more with their franking credits. Some sectors, such as retailing, are struggling but by most measures share valuations are low.

Do not assume the recovery, when it eventually comes, will be a rerun of the bull market in shares between the early 1980s and 2007.

The trend towards low inflation and interest rates that was mostly behind the bull market (as well as companies and individuals loading up on debt) was a one-off.

Investors focused on the rising prices of their shares. The income the shares paid became immaterial. In all likelihood, the game has changed. Investors will be much more focused on the income that is generated as they expect only fairly modest capital gains over the longer term. The swelling ranks of retirees in developed countries can be expected to help drive this trend as they favour investments with good income streams.

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Frequently Asked Questions about this Article…

Why was it a disappointing year for ASX investors?

The market barely recovered after almost touching 5,000 points on the S&P/ASX 200 in April, then traded mostly between 4,000 and 4,500 points for the rest of the year. Overall the index finished about 5% lower than where it started the year, with uncertainty from the euro‑zone debt crisis and worries about global growth weighing on share prices.

How could the euro‑zone recession affect Australian shares and superannuation funds?

A likely euro‑zone recession increases global growth risks, which can unsettle markets. Because many global investors view the Australian market as a resources play, weaker global growth and lower commodity prices can prompt them to reduce exposure. That in turn can hurt the sharemarket and the performance of superannuation funds, since shares are the biggest holding of many default super funds.

What does a high Australian dollar mean for foreign investment in local shares?

A high Australian dollar makes Australian shares more expensive for overseas investors, reducing their appetite to buy them. That lower foreign demand can put downward pressure on share prices, especially in commodity‑linked sectors.

Are dividends a compelling reason to invest in Australian shares right now?

Dividends are increasingly important. Big companies such as Telstra and the major banks are paying cash dividends in the order of 6%–9%, even higher when franking credits are included. With expectations of only modest long‑term capital gains, investors are likely to put more weight on reliable income streams from dividends.

What is the role of franking credits in dividend returns?

Franking credits attach to Australian company dividends and can boost the effective yield that investors receive. The article notes that some large companies’ cash dividend yields of 6%–9% are even higher once franking credits are taken into account, making income from shares more attractive to investors and retirees.

Will the next market recovery look like the long bull run from the 1980s to 2007?

The article warns not to assume a replay of that earlier bull market. The long boom was supported by a one‑off trend toward low inflation and low interest rates and heavy debt loading. Going forward, those conditions are unlikely to repeat, so investors should expect a different type of recovery with more focus on income and more modest capital gains.

Which sectors are struggling and how are share valuations positioned?

Retailing is specifically mentioned as a struggling sector. Despite some positive signals for corporate profits and economic growth, by most measures share valuations are low, reflecting the broader uncertainty and selective sector weakness.

How should retirees and income‑focused investors think about shares now?

With swelling numbers of retirees and a market environment that may offer only modest capital gains, retirees are likely to favour investments that provide good income streams. High dividend payers (for example large telecoms and banks) and the benefit of franking credits can make shares an attractive source of retirement income.