Dividends rediscovered

PORTFOLIO POINT: Investing for dividends has been a neglected strategy for decades, but in a sideways market the real money will be made from double-digit distribution yields.

I have been filmed throwing Zimbabwean dollar notes in the air during a live interview on television and a few months ago I showed up at the ASX Investor Hour wearing an alien costume, but a few weeks ago I did something really crazy.

I used my presentation at the AIA investor conference to present investors with an alternative to the high volatile, high risk situation that many of us face in the share market right now – to participate without paying attention to the share price.

Huh? Say that again?

Last week I proposed that investors start buying stocks and forget all about the share price. Sounds like I am on the road to ruin, doesn't it? Or at least the asylum.

But the simple fact is that the share market isn’t the same place it was five years ago. So why are you investing like it is?

I’m not advocating that we buy stocks willy-nilly but that we do our research, pick our entry and then stop being obsessed by the share price. Just collect the dividends and be happy.

This is a good thing, because if we execute this strategy well, we won't ever want to sell our shares.

Hohoho, I hear you object, am I not missing the point what investing in the share market is all about? It is all about buying low and selling higher surely?

Unfortunately, it's not.

That's what it looks like in a bull market, and since everyone repeats the same mantra over and over again, it becomes "reality". It still doesn't mean that if you are in the game for the long haul you should be playing according to these rules. Think about how things like whiskey and wine require time to age to mature. And so it is with investing.

The difference between a bull market and a sideways market is that in the first case we think we can do better by ignoring these rules of nature, in the second scenario we are ultimately brutally robbed of our illusion.

Let there be no mistake: if you don't like risk then cash is your best friend. However, if you do want to generate superior returns then equities are still the better alternative, albeit with a correspondingly higher risk profile.

The risk in today's market lies not so much with corporate earnings and balance sheets, but with central bank policies, government actions and sovereign debt. The irony is that most companies seem to be in good shape and many of them will grow their earnings in the years ahead. The unfortunate uncertainty for investors is that this does not automatically mean share prices will rise too.

The reality is that with lower trend growth ahead in the two biggest economic zones and with sovereign debt risks continuing to linger, not to mention the fragile banking system in these countries, it is likely the future will see lower valuations in general being priced in for equities - this as a result of the global community pricing in a higher risk premium. Under this scenario, higher profits can still translate into lower share prices.

As far as sovereign risks go, anything is possible when it comes to political processes and budgets in both the US and in Europe.

Can stock markets fall to much lower levels from here? They sure can, especially if we take guidance from the panic driven events in the first two weeks of August. But one would have to have a very dire view on the world in the years ahead to write off the possibility that share markets will not move higher over the long term even, if we don't know over what kind of time frame this will occur.

Which is why my analysis continues guiding me towards dividends.

To put it bluntly: in today's market dividends are less at risk than earnings or share prices.

This might seem odd as investors have always been told to carefully watch earnings as these are ultimately what generate the cash needed to pay for shareholder dividends. As I said above, corporate balance sheets are, on average, in good health and many businesses are generating growth in profits.

A broad-based change in the general climate can impact on this and earnings can end up being a lot less than what seems a conservative estimate today, but a whole lot more would have to happen before we will see a significant reduction in today's sustainable dividends.

Here's one example to illustrate my point: even if the global economy goes into temporary meltdown tomorrow, will the world all of a sudden stop using PET bottles, tin cans and cardboard packaging?

If the answer is no then Amcor's (AMC) dividends look fairly secure. Similarly, what kind of apocalypse are we talking about that stops consumers in Australia from shopping at Woolworths (WOW) supermarkets, Dan Murphy's and Big W?

In my presentation on Thursday I asked the question: did you know there are companies in the Australian share market that have never since listing lowered their dividends? As in never. Not even in the aftermath of the Lehman Brothers collapse?

Others might have cut once (which is not the same as scrapped) but they started adding to them again the following year. Others might have had a hiccup many moons ago, but they have kept growing their dividends throughout the past decade.

Companies that fit in with this profile include Fleetwood (FWD), Campbell Brothers (CPB), Monadelphous (MND), Woolworths (WOW) and Amcor, as well as all the major banks (ANZ, CBA, NAB, WBC).

Taking guidance from fairly secure consensus projections, Fleetwood shares bought today are likely to yield 9% in fully franked dividends in five years’ time. This also happens to be the 'new’ long term average return for the Australian share market as recently calculated by AMP.

A fully franked 9% is superior to 9% in total returns and it certainly beats 6.25% in cash deposits which won't grow and are fully taxable.

Replace Fleetwood with Amcor and we are probably talking 8.5% in five years’ time. Replace Amcor with Wesfarmers (WES) and a similar figure emerges.

Add a few years and you should be talking double digits. This is why I believe investors who should be thinking long term are too often confused and misguided and they thus miss out on the true value on offer in the share market: cheaply priced generators of growing, sustainable dividends.

Want to know what a few years of bull market conditions can do to this approach? Take a look at the following picture:

Admittedly, I don't think it is feasible to expect similar returns in the years ahead when growth will be lower and harder to achieve, but double digit returns are still possible, in my view, if only we allow for enough time.

Think about it. This may well turn out the most important realisation you make for the rest of your life.

Meanwhile, the financial industry itself is gradually turning its focus to sustainable dividends.

On Monday fund manager Gamma Wealth said in a statement: "Currently the Gamma Wealth Management investment team views a number of opportunities with many companies’ balance sheets being quite strong post GFC and producing high sustainable dividend yields.”

“A number of companies in focus as potential entrants for this portfolio include Fleetwood, Cabcharge (CAB), Adelaide Brighton (ADB), Cardno (CDN), United Group (UGL) and Metcash (MTS). These companies have been priced for no earnings growth, yet have strong balance sheets and unique characteristics to their business which has made some of them market leaders in their industry."

Market strategists at Goldman Sachs equally lined up their favourite stocks expected to yield at least 7.5% (grossed up) and believed to be secure and sustainable: Myer (MYR), Bank of Queensland (BOQ), Tabcorp (TAH), National Australia Bank (NAB), Westpac (WBC), ANZ Bank (ANZ), Metcash, Commbank (CBA), Bendigo and Adelaide Bank (BEN), QBE Insurance (QBE), Suncorp (SUN), United Group, Caltex (CTX), JB Hi-Fi (JBH), Leighton Holdings (LEI), AMP (AMP), and Toll Holdings (TOL).

Amongst smaller caps, Goldman Sachs selected: Hills Holdings (HIL), Prime Television (PRT), Cabcharge, WHK Group (WHG), Ten Network (TEN), BT Investment (BTT), Adelaide Brighton, OrotonGroup (ORL), iiNet (IIN), Charter Hall (CHC), Bradken (BKN), DuluxGroup (DLX), Breville Group (BRG), Flexigroup (FXL), TPG Telecom (TPM) and Australian Infra Fund (AIX).

At a time when the question most investors are asking is “when is the next rally”, I remain convinced the true value in today's share market lies with industrial stocks that pay growing, sustainable dividends.

Which is why Ardent Leisure (AAD) remains one of my favourite stocks in the share market. Eight years ago, the shares were trading around $1, which is where they are today. In two years' time these shares will yield 12%, if not more. All I have to do is not sell them.

Rudi Filapek-Vandyck is editor of FN Arena, an online news and analysis service.