Dividends set to return to 85% of pre pandemic levels in 2021

The Australian stock market has long been known as the place to be for income-loving investors. Why? Because company dividend yields in Australia are amazingly high. The dividend yield for 2021 and 2022 is forecast to be 4%-5% plus franking, compared to cash rates and fixed-interest products yielding below 1%.

According to Morningstar, S&P/ASX 200 payout ratios have fallen since 2019 from 81% to 71%, mainly due to the pandemic. Despite the fall, Australian dividends (especially when combined with franking credits) remain an attractive solution for income-seeking investors, when comparing with the rest of the world.

Robert Francis, Australian managing director of global multi-asset investment platform eToro, discusses valid reasons as to why investors should be allocating capital towards dividend-paying stocks. He says, “Despite being popular amongst many investors, especially those who are preparing their nest eggs for retirement, dividend-paying stocks require a touch more research from those who are fresh to the stock market.” Dividend-paying stocks are an important part of an investor’s overall portfolio, especially because these are the least ‘volatile’ to own.

Global asset manager Janus Henderson Investors says there are signs of a revival in Australian dividends following a strong company earnings season: it says dividends should reach 85% of their pre-pandemic 2019 levels by the end of the year. The fund manager compares Australia to the emerging markets, with its reliance on mining and financial services. Both are similar. Being a hybrid economy, Australia is “well placed to take advantage of the recent surge in commodity prices, and strong industrial production in China.”

The advantages of dividend-paying stocks

Investing in dividend-paying stocks is a no-brainer, especially for an investor that is looking for long-term growth. Francis says: “Dividend-paying stocks essentially allow investors to get paid while waiting for capital appreciation. Historically, dividends have provided 43%  of the S&P 500’s total return. They can provide a steady stream of income with little to no work, much like interest in a bank account, but with a greater potential for return on investment (ROI).”

And he’s right… generally most good-quality dividend-paying companies generate sustainable cash flows and are at the mature stage of the company cycle rather than the early stages. A good example is the big four banks.

These stocks usually hold up better in falling markets than more speculative stocks.

Dividend traps of which investors should be aware 

One of the big traps of dividend stocks is what happens when that company lowers or cancels its dividend altogether. During periods of economic downturn, companies experience reduced cashflow and financial hardship; because of this, they may reduce their dividend – even scrap it altogether – just to survive. “An example of this was in the wake of the global pandemic: many companies, in particular in the travel, leisure, oil, and gas industries, decided to cut their dividend payouts in order to adequately make internal ends meet,” says Francis. “Companies ranging from Nordstrom to General Motors suspended their dividends in 2020, while companies known for their reliable dividend allocations, like Shell, suspended its dividend for the first time since WWII.”   

Investors should note: a high dividend yield may not necessarily mean a high dividend payout. A company’s high dividend yield could have been caused by significant drop in share price. A falling share price usually means falling earnings, suggesting financial trouble. In addition, future interest rises could potentially make dividend stocks less attractive.

Outlook

Looking ahead, surging iron ore and commodity prices will see resource stocks lift dividends, with the possibility of one-off special dividends. Matt Gaden, head of Australia at Janus Henderson, says: “Our outlook clearly points to a dividend revival in Australia after a dividend drought last year.

“A key factor for the dividend drought is the heavy concentration towards banks and mining stocks in Australia compared with other global markets which are much more diversified. As the economic recovery continues, we’re anticipating further dividend increases, with payouts reaching 85 per cent of their 2019 levels. The dividend bounce back should be a big relief to Australian investors, particularly self-funded retirees.”

Jane Shoemake, client portfolio manager on the global equity income team at Janus Henderson, says: “Despite this uncertainty, we are more optimistic given that Q1 was undoubtedly better than expected, and we are now more confident that companies are willing and able to pay dividends, especially those companies that have traded well… special dividends will play a role too.

“Since late last year, we have been adding to areas of the market that will benefit as economies reopen and where there is increased confidence in a business’s ability to generate cashflow and pay a dividend. As we move into the second quarter, the year-on-year comparisons will look very positive, because it was the worst period for dividend cuts last year.”

Overall, Janus Henderson is estimating dividend growth to hit around 40%, taking total payouts to $70.9 billion, about 85% of the FY2019 level. But the firm cautions that there is still a high degree of uncertainty around the near future, both in Australia and around the world.

Ishan Dan

Ishan is an experienced journalist covering The Inside Investor and The Insider Adviser publications.