The Power of Dividends

Australian companies are well known for their dividend paying prowess comparative to other international markets and has been a cornerstone of many portfolios for the past 30 years. I’m sure you’ve heard someone say ‘I don’t like the banks, but they keep paying good dividends’ at a gathering and wondered what were they really talking about?

In this blog, we'll explore the ins and outs of dividend investing, focusing on key elements such as dividend payments, impact on share prices, franking and tax implications.

Understanding Dividend Investing

Dividend investing involves strategically selecting stocks that pay out a portion of their earnings to shareholders in the form of dividends. These payouts are a tangible return on your investment, providing a steady stream of income. This approach is particularly appealing for Australian investors seeking to diversify their portfolios and generate passive income.

Dividend Payments

When a company generates profits, it has the option to reinvest those profits back into the business or distribute them to shareholders as dividends. Dividend payments are typically made on a regular basis, often quarterly, biannually or annually. Investors can sometimes choose to receive these payments as cash or reinvest them to purchase additional shares, compounding their investment over time. How much the company pays out as a dividend will depend on their recent performance, how much profit was made and what their pay-out ratio is.

Impact on Share Prices

The announcement of dividend payments can influence a company's share price. When a company announces a dividend, it will tell you the ‘ex-dividend date’, which is the date you need to own the shares by to receive the dividend. Once the ‘ex-dividend date’ occurs, you will usually see a drop in the companies share price roughly equivalent to the amount of the dividend paid. This is because the company now has less value because it has/will pay out a dividend to its investors.

As an example, here is the share price of ANZ on two dates:

ANZ share price – 01/01/2014 = $29.89

ANZ share price – 01/01/2024 = $26.59

On face value, this looks like a poor 10 year run with a capital value loss of 11.04%, however over that time, ANZ paid out $14.39 in dividends taking the 10-year return to $11.09 per share or a 37.10% gross return.

Ideally, we would like to see capital growth as well as dividend growth, but the example shows the power of consistently paid dividends.

Franking Credits

One distinctive feature of the Australian dividend landscape is franking credits. In an effort to avoid double taxation, the Australian government introduced franking credits, also known as imputation credits. These credits are attached to dividends and represent the tax the company has already paid on its profits. For investors, franking credits can significantly enhance the after-tax return on their investments.

Tax Considerations

Dividend income is taxed at the investor's marginal tax rate. However, with the benefit of franking credits, investors may receive a credit for the tax already paid by the company. This can potentially result in a lower effective tax rate on dividend income. It's essential for investors to understand their individual tax situation to optimise their tax outcomes.

Diversification and Risk Management

Incorporating dividend-paying stocks into a well-rounded investment portfolio can contribute to diversification and risk management. Companies that have a history of paying dividends tend to be more established and financially stable. By spreading investments across various sectors and industries, investors can mitigate the impact of poor performance in any single sector.

Dividend investing is a time-tested strategy that aligns with the objectives of many Australian investors. The combination of regular income, franking credits, and potential capital appreciation makes it a compelling option for those looking to build and preserve wealth over the long term. As with any investment strategy, careful consideration, ongoing monitoring, and professional advice are crucial to success in the dynamic world of finance.

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