Dividends are a significant part of the return investors receive from investing in shares. According to data sourced from Jarden, the S&P NZX All Share Gross Index has returned 13.7% pa over the past ten years.
The S&P NZX All Share Capital Index has returned 10.7% pa over the same period. Therefore, dividends have returned 3% pa over the last ten years representing about a quarter of the total gross return investors have received from the NZ sharemarket.
In earlier periods, when share price growth was slower, dividends would have comprised a higher proportion of the total return from shares. US research that I discovered claims that almost half of the S&P 500 Index returns over the last 100 years have come from dividends.
Dividends distribute profits to shareholders. Dividends reward investors for providing equity for businesses. Dividends receive close attention from investors for understandable reasons.
Dividends are a guide to a company’s financial health and indicate the directors’ confidence in a company’s future. If profits drop or vanish, dividends can get cut or passed but listed companies with a long history of increasing dividends are strongly favoured by investors.
Directors know that dividends make a considerable contribution to shareholder returns and in NZ, boards generally employ a fairly high dividend payout policy (about 85% of net profits).
In part, this generous distribution policy reflects the tax regime that applies to NZ company dividends. In NZ, company tax can be ‘imputed’. In other words, shareholders can receive a credit for the tax paid by the company on the profits distributed to them as dividends.
This eliminates the double taxation of dividends. These tax credits have no value to the companies but have a major bearing on the post-tax return to NZ shareholders. Australia, Chile, Canada, and Mexico have similar dividend imputation tax systems.
Other countries like the US, UK, Ireland, and Germany do not. Some countries offer concessional tax rates on dividend income.
The percentage of a NZ company dividend that is imputed depends upon the proportion of the company’s profits subject to NZ tax. Spark, for example, can fully impute its upcoming 12.5cps net final dividend.
This means that NZ resident tax-paying shareholders can use a tax credit of 4.86c per Spark share to offset their tax. Ebos, in contrast to Spark, earns a large portion of its taxable profits in Australia and therefore imputes about 25% of its dividends for its NZ shareholders.
This is simply an outcome of decisions made by the Ebos board to grow the company’s business in Australia. The modest amount of dividend imputation does not necessarily detract from Ebos shares. Dividend-paying companies help reduce portfolio volatility.
As noted, dividends depend on a company’s profitability but will be paid irrespective of the short term share price. Investors find comfort in owning shares with reliable dividends.
History shows that shares in non dividend paying companies are more volatile than those that pay dividends. According to Investopedia, the beta of dividend-paying companies comprising the (US) S&P 500 Index was 0.98 between 2000 and 2010 whereas the non-dividend payers had a beta of 1.48.
In other words, the non-dividend payers (aka growth stocks) moved up and down by almost 1.5 times that of the share market. I prefer a blended approach to share portfolio construction.
Investors could consider populating portfolios with dividend and growth stocks with the weighting reflecting risk preferences and the need/desire for income.
Seasoned investors know (and research supports this) that during the good times, growth stocks outperform but they do carry greater risks partly due to the high anticipation of future success already built into market valuations.
The likes of Spark and property companies like Precinct might not offer much earnings growth but provide a reasonable degree of dividend certainty.
The electricity companies until recently occupied the ‘high reliability of dividends’ category but with the Tiwai Point smelter’s future in doubt, brokers have reduced the dividend estimates for the electricity generation/ retail companies on the back of lower profits.
However, these dividend yields remain attractive relative to bank deposits and corporate bond yields.
Samantha Sharif, in the ‘What’s Best for NZX Investors: Dividends vs Capital Gains’ article, wondered why NZ share investors focus so much on dividends. She noted that the regulatory and tax environment was “detrimental to dividend-paying companies and conducive to growth companies.”
I see things differently. As a result of dividend imputation, the NZ tax system is kind to NZ tax resident investors as I have explained above.
I think it quite appropriate for NZ shareholders to seek dividends from their share investments. As I have said, there is a place for growth stocks which, if able to fulfil the high expectations held for them, can produce outstanding returns streets ahead of the reliable dividend payers.
In these days of historically low-interest rates, dividends have assumed greater importance. The NZ market average pre-tax dividend yield is around 4%, which is attractive relative to alternatives.
Sure, there are greater risks than other interest rate products, but the additional yield plus capital growth potential of selected shares might be seen as adequate compensation. NZ share investors’ dividend fascination is not misplaced.
NZ company directors know that their shareholders will be content if dividends are paid regularly and rise steadily in keeping with the trend in profits. They see dividends as an important component of total share investment returns.
Source: Barry Lindsay from NZ Shareholders Association
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IMPORTANT: This article is of general nature only and readers should obtain advice specific to their circumstances from professional advisers.