More dividends not something to bank on

A big reason bank stocks have been such a smash hit with investors this year is their great dividends.

A big reason bank stocks have been such a smash hit with investors this year is their great dividends.

Why settle for returns of about 4 per cent on a one-year term deposit, the argument goes, when you can get a more tax-effective return well above 5 per cent from bank shares?

It's a fair point. But before getting swept up in the search for yield, you should be aware that bank dividends are unlikely to grow as quickly as they have in the past.

The latest set of profit results further underlined the capacity for banks to pay shareholders a healthy income stream.

NAB raised its dividend by 3 per cent, ANZ smashed expectations with an increase of 11 per cent and Westpac chipped in with a one-off special dividend.

However, analysts argue the spectacular growth in payouts enjoyed by ANZ and Westpac shareholders is unlikely to continue in the long term.

The most important reason for this is the "payout ratio" - a number that has become much more interesting to yield-obsessed investors lately.

Put simply, bank dividends have been super-sized in recent years by banks paying out a higher share of profits.

As the graph shows, the share of profits being paid out by the big four - known as the payout ratio - has risen from about 65 per cent a decade ago to 72.5 per cent now.

But it is unlikely to rise much further.

For one, Commonwealth Bank, NAB and Westpac have already raised their payout ratio to 75 per cent. This is far more than banks overseas pay out as profits and it's hard to see boards approving payout ratios getting much higher.

This is because companies generally hate cutting their payout ratios during bad times, which annoys shareholders. To avoid this, they take a conservative approach.

If banks do build up extra capital in years ahead, experts reckon they are more likely to give it back to shareholders as special dividends, rather than increasing payout ratios further.

ANZ might still increase its dividend payout ratio a bit more. It has been paying out a smaller share of profits than its rivals because it's using its spare cash to invest in Asian expansion, and its latest move was an attempt to narrow this gap. However, it also said it did not plan to increase its payout ratio all the to way 75 per cent.

All up, more gradual growth in bank dividends looks most likely.

Of course, the absolute cash value of these payments might keep rising as bigger profits roll in. But they are unlikely to be turbo-charged by boards giving back a larger slice of the profits.

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