Now for the dividend rebound

The big banks look set to regain their place as the biggest dividend payers in the market. Picture: NCA NewsWire / Christian Gilles

In the unlikely event you missed it. Share prices just had their best year since 1987 with the ASX 200 gaining 24 per cent in the 12 months to June 30. But when it comes to dividends the recovery is yet to come.

Unlike many overseas markets the ASX is a dividend paying machine - the regular income payouts to investors represent the backbone of Australian investing. With a market wide dividend yield just now of about 3.9 per cent we are still well behind the level we were three years ago.

What’s more we can’t reasonably expect the stellar run on share prices to keep going. The ASX has already gained 10 per cent in the last six months. The majority of analysts do not expect a similar performance in the run up to Christmas.

Look at it this way, the benchmark ASX 200 is now at 7300. The consensus among the biggest investment houses in the market suggest a level at the end of 2021 of 7460. That’s a return of 2 per cent for the rest of the calendar year.

Indeed some brokers - such as Morgan Stanley - suggest the ASX will close lower at year end than where it stands today.

Why” Because the prices on the market are stretched, because profit growth might remain strong, inflation is rising and the progress of the pandemic is far from clear.

“It just makes you realise that dividends are going to remain very important,” says Don Hamson of Plato Investment Management.

Keep in mind that our market generally pays a dividend yield roughly twice as high as overseas markets such as the US What’s more we have franked dividends among our leading stocks which means that on an average year when share prices more typically return say 6 per cent (rather than 24 per cent in the last 12 months) it is the dividends that carry home total sharemarket returns to beyond 10 per cent.

Now the good news is that while the steam may come out of share prices later this year, dividend payments are on the way back to ‘‘normal’’ thanks to the fact that banks and miners make up more than 50 per cent of our market.

If you look closely at what happened in the 12 months to June 30, of course there are eyebrow raising stories around Afterpay or Lithium stocks but the big rebound was carried largely by seven companies. ANZ, CBA, NAB, Westpac, BHP, Rio and Fortescue.

In the year ahead the opportunity for even better performance is seen to be with the banks.

Analysts suggest bank yields just now are now moving towards 5 per cent and after franking that will work out closer to 6.5 per cent.

Matthew Davison, senior research analyst at Martin Currie Australia has been focusing on bank stocks and he reckons they are just about to start lifting their dividends thanks largely to what he calls the “unprecedented acceleration” in house prices that just swept the land since Mid-2020. Davison reckons the house price jump does not just improve credit growth for banks but rewrites the entire backdrop with better than expected bad debts which in turn feeds into lower provisioning costs than might have been expected even a few months ago.

“We like the dividend opportunity in all the banks,” says Davison, who is working on the basis that the big banks are heading for record annual dividend growth of 17 per cent.

Dividend growth has been the holy grail in recent times as official rates remain at rock bottom. Annual growth of 17 per cent is shooting it out of the park - it‘s more than triple what you might expect for bank dividends in an average year.

Which of the banks for income? ANZ, NAB, Westpac and CBA in that order due to “potential for provisions to better reflect bad debt unwinding, capital returns and improved credit growth”, says Davison.

CBA is, of course, the leader of the bank sector however that position comes with a price. With its stock touching $100 the bank now has the lowest yield among the big four.

As the banks move to regain their place as the franked dividend lords of the local market, the miners also look capable of extending their new found role as generous dividend providers.

Keep in mind it was the newest member of the big dividend payers, Fortescue, which muscled Westpac out of the top six dividend payers last year.

The miners can be expected to continue paying high dividends because they dig iron ore out of the ground for less than $US20 and are currently selling it for $US210 a tonne.

In the hunt for dividend yield market analysts will generally favour banks over miners on the assumption the banks are less likely to let you down when things turn down. However, during the early phase of the Covid crisis we found out the big banks can turn the tap off just as fast as any miner faced with a sudden deterioration of conditions.

Marcus Padley of the Marcus Today newsletter recently spelled out the remarkable level of dividends from big miners when you include franking. BHP is on 9.9 per cent, Rio is on 14.1 per cent and Fortescue is on 15.4 per cent. Padley then pointed out that all of these stocks are tightly correlated to commodity prices which are currently surfing the top of the cycle. “Never stand like King Canute saying stocks are cheap when commodity prices drop,” he warned.

Either way, it‘s an opportunity ready to be exploited by any investor looking for income. We have the miners most likely at the top of a dividend cycle but with plenty of earnings momentum still left in the system. Meanwhile, the banks are only beginning to regain the prize as the dividend kings - and in the months ahead it looks like dividends are going to matter a lot more than they did over the last year.