Dividends don't grow on trees

When headlines like 'Mid-tier miners join the yield play' start hitting your inbox, it leaves little doubt as to what is driving decisions about capital allocation in corporate Australia. So long as the yield on offer in equities remains attractive relative to fixed income assets, dividend-paying stocks will remain heavily bid. However, some observations from reporting season should serve to keep investors mindful in their pursuit of dividends. 

Commsec's Chief Economist, Craig James, points out: "So far 101 companies of the ASX200 have reported half-year earnings: aggregate cash balances are down 11.3% and aggregate dividends are up 7.4%.” In theory 'dividend investors' should be happy. However, with all this capital being directed toward dividends what is happening to earnings? 

The team at FNArena have monitored the results of 160 companies including broker ratings and consensus target price changes. Their analysis reveals that consensus ratings upgrades have been recorded on just 24 occasions with downgrades recorded on 78. 

The downgrades reflect a couple of issues. Firstly, brokers are clearly saying that share prices, in many cases, are now fully or over valued (no huge insight there). The second point is that downgrades are also reflective of the subdued earnings growth for companies on the ASX. Indeed, as this chart from Macquarie Research illustrates, earnings growth has been quite elusive for a number of years with a clear downward trend in earnings expectations in recent years. 

There is a limit to how much can be achieved when cost cutting before fresh investment is required to stimulate earnings. Falling cash balances should also act as a flag for investors. Dividends don't grow on trees and for those hunting yield it is worth taking the time to understand where the next one is coming from.

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