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Retail investors of all types frequently prowl the ASX in search of safer shares.  Even the most aggressive and experienced retail investors sometimes tire of the relentless pounding their investments take during turbulent market conditions.  Cautious new investors as well as investors whose goals call for stability rather than growth look to shares where safety is more important than spectacular gains.

Conventional wisdom says shares in companies that pay dividends are safer investments.  This sounds like simple common sense, since only a stable and profitable company can afford to return some of what it earns to its shareholders as dividends.

Heeding this advice, some new investors do a little reading and come across Dividend Yield as a metric to use.  So they use a stock screener tool to find shares with the highest dividend yields.  Considering the willingness of governments everywhere to prop up the big banks if necessary, many investors look to bank shares.  Here is a table reflecting the Dividend Yield of four of Australia’s biggest banks:

Share Symbol Dividend Yield
 NAB (National Australia Bank) 6.11
 ANZ (Australia & New Zealand Banking) 5.52
 WBC (Westpac Banking Corporation) 6.01
 CBA (Commonwealth Bank of Australia) 5.71

 

The data do not suggest a clear choice.  However, if you take the time to dig into what dividend yield actually means, a different picture emerges.  Here is one formula for calculating dividend yield:

Dividend Yield = Annual Dividends Paid per Share/Price per Share

Math wizards immediately recognise the influence of price per share on the yield – the lower the price the higher the yield.  This points up the first trap you need to know about browsing through a list of shares in search of the one with the highest yield.  Without further research, it is possible to invest in shares where the high yield is due to declining share price – a company that might be in trouble.

In our example, it would appear there would be little difference in choosing any of the four banks based on yield only.  However, you need to know the value of the numerator in the formula – the actual dividend paid.

NAB, ANZ, and WBC all paid around 74 cents per share in dividends and are currently trading (2011 March) around $24.  CBA pays a heftier dividend of approximately $1.30 per share, but it trades around $53.  The moral of this story is simple – “bang for your buck” can be greater from lower priced shares with similar yields to higher priced shares.  

Do the math for a $6500 investment in both CBA and ANZ.  At current prices, you would end up with roughly 120 shares of CBA and about 270 shares of ANZ.   The $1.30 dividend from CBA would return $156 while the 270 shares of ANZ with a dividend of about 74 cents per share would return around $200.

As is the case with most financial metrics, dividend yield and dividend payout are backward looking.  There is no guarantee the shares will continue to pay the same dividend in the future, nor will the share price remain static.

Therefore, the wise investor looking for safety in the dividend yield looks to a longer period and dividend growth.  Calculating a share’s dividend growth rate is not something you want to do on your own.  Courtesy of Morningstar Australia, we can compare the Dividend Growth Rate of these four banks annualized over 10 years, 5 years, and 1 year.  Here is what the numbers look like:

  Dividend Growth 10 Year Dividend Growth 5 Year Dividend Growth 1 Year
 NAB 1.3 -1.8 4.1
 ANZ 6.8 2.8 23.5
 WBC 9.4 6.8 19.8
 CBA 8.8 8.0 27.2

 

Immediately you can see the impact of the global financial crisis.  All these shares showed lower growth in the five-year period, with NAB actually showing a decrease in dividend.  The picture for the past year is much brighter.  What’s more, it adds evidence that ANZ might be your share of choice.  Their dividend growth of 23.5% closely approximates that of CBA’s 27.5% and as you now know, the price per share difference means you can buy more shares of ANZ and get a higher dividend return.

The final problem to address when it comes to dividend paying stocks is the future.  Performance over the past 10 years is generally a good indicator a share can continue to perform well.  There are no guarantees of anything about the future, however, companies do provide projections or estimates of future dividends, and once again, courtesy of Morningstar Australia, we can have a look at them.  Here are the 2 Year Forecasts for each bank:

  2 Year Forecast – Dividend Growth
 NAB 9.1
 ANZ 11.1
 WBC 5.8
 CBA 8.2

 

Clearly, Australia and New Zealand Bank sees more dividend growth in the future than do the other banks.  Does this mean you should run to your broker or trading platform and buy this share?

Most Australians contemplating a major purchase such as a new laptop or notebook computer do exhaustive research on available products.  Would you buy a high-priced machine based solely on its chipset?  Some Australians do and later learn system memory is often more important than processor speed.  The point is, why would any retail investor be willing to throw hard earned cashed into a share based on a cursory review of a few financial metrics?

While ANZ’s past performance in paying and maintaining a respectable dividend coupled with their assurance they will continue to do so are positive signs, wise retail investors know they are no more than a license to search further.  It takes time and patience to learn what you need to know about the business of your target company.  Metrics like dividend yield help separate the “wheat from the chaff,” but not all wheat is created equal.

Financial metrics help you avoid wasting time on shares with poor prospects.  In the case of ANZ, before you buy, you need to understand their business.  Do not assume you understand how a bank operates and the business model it follows.  This means taking the time to read their annual report as well as research reports from professional analysts.  When it comes to finding safer shares, there is no substitute for hard work.