Positioning for a share of the spoils
While earnings growth remains weak, the role of dividends falls into focus, writes John Kavanagh.
While earnings growth remains weak, the role of dividends falls into focus, writes John Kavanagh. Stock analysts reviewing the recent round of December half-year profit reports have used words such as "mixed", "tough" and "lacklustre" to describe the results. But when it comes to dividend payouts they have been much more positive.The consensus view is that dividend growth will be the main source of shareholder returns in the year ahead and investors should be looking for stocks with good track records of consistent earnings growth and above-average dividend yields.CommSec reviewed the results of 131 companies in the S&P/ASX 200 Index that reported half-year results for the six months to December 31.Of the 131 companies, 85 per cent were profitable. But only 61 companies (47 per cent) reported an increase in profit.The half-year profits of those companies rose by an average of 5.5 per cent. Average revenue was up 9 per cent but expenses were up 10 per cent.CommSec also looked at 24 companies in the S&P/ASX 200 that reported full-year results for the 12 months to December.Full-year results were down by 45.2 per cent. According to CommSec, this big drop was due largely to one company, Caltex, making a large asset write-down.WeaknessAMP Capital says the weakness in the December-half earnings was broad-based. Resource company earnings were down slightly, banks were up a little, while other industrials were flat.Falls in commodity prices, lower demand for finance, stresses created by the strong Australian dollar and weaker consumer spending were all factors.While the earnings figures were disappointing, CommSec says the good news for investors is that 79 per cent of companies issued a dividend and the average dividend payment was up 7 per cent on the dividend paid on December 2010 half-year earnings.The head of equity strategy at Morningstar, Ross Bird, says: "With balance sheets generally in good health, companies are aware of the need to reward shareholders through dividend growth to supplement the modest levels of capital growth since the global financial crisis."Analysts are recommending share investors develop their strategies with these factors in mind.An investment strategist for AMP Capital, Shane Oliver, says: "With corporate cash holdings at record levels and with gearing low, there is plenty of scope for further increases in dividends, buybacks and other corporate activity."Oliver says the Australian sharemarket is trading on a forward price-earnings ratio of 11.5 times. This is down from 12.9 times a year ago. P/E is calculated by expressing the share price as a multiple of earnings per share. A forward P/E ratio uses estimated future earnings in the calculation. Oliver says the long-term average for the market's forward P/E ratio is 14.5. On that basis, stocks are cheap.If the market starts to return to that long-term average, there would be strong share price appreciation. However, there is a lot of uncertainty about when that appreciation might begin.Macquarie Equities says a return of P/E ratios to the long-term average is unlikely this year. It says: "In the current environment, where the delivery of earnings is highly uncertain, dividend yield is an increasingly important component of returns. Yield has contributed most of the total returns to investors over the past five years."IncreasesAn investment adviser at Evans & Partners, Ian Glass, says: "Dividend increases have been noticeable in this reporting season."Evans & Partners is confident that all four of the major banks will be able to maintain, if not increase, the dividends for the foreseeable future."And with share prices looking relatively cheap, dividend yields are elevated, growing and sustainable thanks to the balance sheet repair undertaken in 2009."Bird says: "The positive profit stories in the December-half reports are confined largely to companies in the small- and mid-cap sectors. They were nimble enough to steer through a challenging macro-economic environment and take advantage of changing structural themes, while large enough to have scale and manage costs.Strong performersSome mid-caps on Morningstar's radar include Domino's Pizza, whose half-year net profit rose 23 per cent Caresales.com.au (net profit up 20 per cent) Mermaid Marine (up 35 per cent) and Ausdrill (up 23 per cent)."The large-cap companies are more exposed to broad economic influences," Bird says."A snapshot of the 20 largest listed companies reveals the important contribution dividends are making to investor returns. The weighted average rise in dividend payouts for top-20 companies reporting half-yearly results to December was 6.2 per cent."An equity strategist for Citigroup, Tony Brennan, says lower corporate borrowing levels since the financial crisis have contributed to lower earnings growth. However, the benefit of lower gearing is that companies have plenty of capital for dividends and share buybacks.