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Problems with the yield play?

24 May 2015  |  Investing

yieldThe average number of stocks held by SMSFs is 18, with a heavy concentration on the banks, Tesltra and the major miners. This has proven to be a sound play because of the high dividend yields, especially the banks and Telstra. Even if there is negligible share price growth, the income has justified the investment.

But of course dividends are dependent on earnings, and there may be signs that they are coming under pressure. The AFR is commenting that the Australian sharemarket could face an abrupt end to its yield-driven ascendancy as lacklustre earnings growth and rising debt combine to pressure dividend payments:

 

"Over the past three years dividend darlings including Telstra and the big four banks have enjoyed sharp share price rises as investors hunt for stable returns amid historically low bond yields.

But Credit Suisse warns that payout ratios (the percentage of earnings paid out as dividends) are at 21-year "extreme highs", and the yield support behind some of Australia's biggest stocks could falter.

"Higher dividend payouts have been funded through increased debt and gearing rather than earnings, and current gearing and [debt] serviceability levels are potentially indicative that corporates do not have much more wriggle room to squeeze up payout ratios using debt," Credit Suisse analyst Richard Hitchens said.

"Based on negative market reactions to the recent interim dividend misses within the yield-darling banking sector, a declining market-wide dividend payout ratio could be a headwind for the Australian market in the medium term."

Following their interim results this month, National Australia Bank, ANZ Bank, and Westpac, were all sold off by investors when their dividend payments failed to meet market expectations.

Major miners BHP Billiton and Rio Tinto will also struggle to increase their dividends given the weakness in prices for key commodities, such as coal, iron ore and oil, and analysts are forecasting weak dividend growth for Telstra due to intensifying competition."

 

If dividends do start to get funded by debt, then that is a definite warning sign of trouble to come. Dividends paid out of profits are sound, but borrowing to create divifends is a form of financial engineering that rarely ends well. Investors should be watching these developments closely.

 

 

 



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