10 top dividend paying stocks

When the sharemarket falls by 20 per cent or more – as it has done since November – one of the major comforts to an investor is the dividend income from shares.

It comes from a company’s earnings, so it’s not affected by the share price. So the dividends being paid this year – usually in April and October, for companies with a June 30 balance date – will come in very handy for many shareholders.

The humble dividend is often overlooked, but it is a vital part of the overall return from the stock market.

Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors, says that between 1900 and July 2007, Australian shares delivered average total return of 12.6 per cent a year – of which return dividends accounted for precisely half, at 6.3 percentage points.

This echoes overseas findings. According to ABN-AMRO’s Global Investment Returns Yearbook 2006, UK shares have returned an average of 9.8 per cent a year since 1900: of this, 4.9 per cent – exactly half – comes from dividends.

In the US, the return from shares is the same, at 9.8 per cent, but the contribution of dividends is lower – at 4.6 per cent, dividends account for almost 47 per cent of total return.

James Foot, head of research at financial advisory group Centric Wealth, says the Australian market has been a “really fertile source” of steadily growing dividends, and that dividend stream has been significantly less volatile than capital growth. But he says investors should realise that both earnings and dividends “tend to be trend-reverting.”

“When earnings reach a cyclical peak, a high dividend yield doesn’t necessarily signify good value,” he says. “As share prices have come off, some shares are now offering very attractive yields, but if you’re using prospective earnings, some of those yields might not come through.”

Foot says high fully franked dividend yields are particularly attractive to investors. “Even those in a high tax bracket can use the tax credits in fully franked dividends to reduce their tax liability on the dividend, and it gets better as your tax rate decreases,” he says.

An individual on a marginal tax rate of less than the corporate tax rate of 30 per cent – for example, a self-managed superannuation fund (SMSF) paying a tax rate of 15 per cent – can claim cash rebates on any excess franking credits they can’t use to offset tax on the dividend: the rebate can be used to offset tax on any other income.

It’s even better for an SMSF that has begun to pay a pension: it pays no tax on the earnings or capital gains in the fund, but it is still entitled to the franking credit – it gets the entire amount in cash. For such investors, a dollar of fully franked income is effectively worth more than a dollar.

But Peter Quinton, head of strategy at Bell Potter, says investors looking at the high dividend yields on offer have to consider the possibility of earnings downgrades.

“Some of those potentially attractive yields will turn out to be mirages. You need to see dividend cover high enough such that even if there is earnings disappointment – earnings downgrades – the company can maintain the dividend.”

Quinton looks for dividend cover (the number of times that a company’s dividend is covered by its net profit) of at least 1.3 times, which implies a 30 per cent buffer of earnings over the amount required to pay the dividend. “But if you’re using that as your cut-off, the only stocks that you end up with, that have a high fully-franked yield, are the major banks and Macquarie Bank.”

Many investors, he says, are prepared to invest on a dividend cover as low as 1, which implies that the company is paying out its entire net profit as dividends. “Any company can give you a high dividend yield if it pays out all of its profit. But paying out all of its profit means that if there is any profit downturn at all, that dividend yield will not be there – if it’s a 100 per cent payout, the company will have to cut the dividend back in line with the lower profit.”

Even more alarming, he says, is a dividend cover below 1 – where the company is dipping into reserves to pay its dividend. “That’s generally bad news, but if there’s a one-off specific reason for it in the current year, and you know it won’t recur, you can accept it. They’re just smoothing the dividend, and if you have every reason to expect that next year is going to be a great year, I can wear that.

“But I have a problem when the company has a payout of 100 per cent or more, and there are issues about next year’s profit as well. A lot of people buy that sort of company, and wonder why, 12 months down the track, they don’t get that yield.”

For this reason, Quinton says it’s not enough to look at the potential yields on offer, based on lower share prices. “You can see double-digit yields on the market at the moment, but most of them are probably a mirage. That’s the bit that most people don’t get. The banks’ yields, and what that comes to for a 46.5 per cent taxpayer, is basically what’s achievable for listed equity, because we know the banks aren’t going to cut their dividends.

“Even if we have further earnings downgrades from the banks – which, frankly, is possible, if not highly likely – their dividend cover is between 1.3-1.5 times. They could have huge earnings declines and they could still pay their dividends. That’s the benchmark.”

Companies with fully franked yields as good as the banks, with roughly the same dividend cover as the banks, are “few and far between”, says Quinton. “When you see high yields, 7-10 per cent, they often have some pretty awful financial parameters underpinning that yield.”

Top Dividend Yields on the ASX

* interim and final, in any order
Source: Goldman Sachs JBWere