n stocks have paid higher dividends than most global stocks. According to 2011 Russell Investments/ASX Long-Term Investing Report, over the past 20 years, Australian equities have outperformed all other asset classes, including real estate, fixed-income instruments and cash. Dividends have accounted for an increasing share of this total return on equities. In fact, according to SSgA Research and FactSet, on a cumulative basis, dividends contributed more than a third of Australian equities' total returns since 1980. Over the past 10 years through December 2011, that proportion has increased to about 45% of Australia's total equity returns. With 10-year government bond yields sitting close to record lows and given the modest growth outlook for the next five years, Australian dividend stocks stand ready to continue their overperformance relative to other asset classes.
Investors should scout through the Australian equity market in pursuit of attractive income plays. In general, the Australian stock market as represented by the All Ordinaries has a trailing dividend yield of around 4.44%. The forward-looking dividend yield is closer to 6.0%. In comparison with the 10-year government bond, the broad stock market's average dividend yield is 110 basis points higher, suggesting that either stocks are cheap or the 10-year government bonds are overvalued.
Yielding more than government bonds, equity income investments based on dividends can also be a way to beat inflation. While fixed-income investments can hardly pay enough to beat inflation, dividend stocks with increasing payouts, assuming all other things stay the same, can secure positive real returns. In fact, according to Credit Suisse Global Investment Returns Yearbook 2011, the long-term growth of dividend stocks in Australia between 1900 and 2010 was 1.1 percentage points higher than the rate of inflation.
Investors should also recognize the fact that dividends paid by Australian companies are worth more than the actual amount of their cash dividend paid. This is so because of a specific tax situation. Given that Australian corporations have already paid taxes on their profits prior to distributions, tax credits known as franking credits are assigned to the dividends these companies pay to their shareholders. Franking credits are a form of dividend imputation aimed at reducing or eliminating the double taxation of dividends. Investors can use franking credits to offset taxes payable on their other income. For franked dividends, there is no withholding tax. For unfranked dividends, a 30% withholding rate would apply, unless there is a more favorable tax treaty arrangement.
Ways to Invest in Dividend-Yielding Equities in Australia
Income investors in the Australian equity market have plenty of options to invest in dividend-yielding securities. One way to benefit from high yields on equities is by investing in exchange-traded funds (ETF
s). Two ETFs that offer exposure to Australian dividend-paying equities are Australia-listed Russell High Dividend Australian Shares ETF
(ASX: YRDV) and the U.S.-listed WisdomTree Australia Dividend Fund
Arca: AUSE). The former ETF overweighs financials, and has an annual expense ratio of 0.46% and a distribution yield of 5.5%. The latter ETF has a broader exposure to consumer sectors and financials, and carries an expense ratio of 0.58% and a dividend yield of 4.7%. Below is a table that shows the largest holdings in each of these two dividend ETFs. Most of the holdings are high-yielding dividend stocks.
However, a recent UBS study cited by Australian Financial Review concludes that “high-yield strategies have not outperformed in Australia over the past 20 years” because “high-yielding stocks have typically passed the mature phase of the company lifecycle and are in decline.” Therefore, investors should focus on total returns driven by capital appreciation and dividend growth.
More conservative investors seeking total returns based on consistent dividend growth and sustainable yields as well as capital appreciation should consider investing in a select group of Australian stocks branded as Dividend Aristocrats
. Based on the S&P Pan-Asia Dividend Aristocrats, these stocks represent the constituents of the S&P Pan Asia Broad Market Index (BMI) with consistent dividend increases for at least seven years in a row. Investors can choose from 11 Australian Dividend Aristocrats listed on the Pan Asia exchange. Some of the Australian Dividend Aristocrats mentioned in the table below offer a combination of attractive dividend yield, sustainable payout ratios, and robust dividend growth.
Investors should also evaluate the following stocks with attractive yields, growth-geared dividend payout ratios, and dividend growth capacity.
A dividend-focused investment strategy, especially the dividend-growth oriented approach, is appropriate for the current low-growth environment coupled with declining yields on government bonds. In that sense, dividend investing in Australia can provide above-average total returns that can beat inflation and the long-term performance of alternative asset classes.