Dividends vs growth

The advantages of franking credits compared to low-interest-bearing term deposits and bank accounts are making investors hungry for dividends. However in the process of paying out to shareholders, managers are forgetting about growing their own companies at the expense of keeping shareholders happy in the short term.

There are times when increased dividends are warranted. Just ask loyal Suncorp (ASX: SUN) shareholders who stuck by the company during and after the GFC. They have been rewarded with special dividends after the share price remained in the gutter following years of consolidation of bad debts.

As seasoned investors know, when a company grows rapidly over a number of years and profit increases become thin, dividends need to be put in place to keep shareholders happy. At the moment, it seems many companies have grown worried about the future and opted to pay out higher yields to shareholders.

Coca-Cola Amatil (ASX: CCL) announced a 9% reduction in profit for FY13 and paid a special dividend while IAG (ASX: IAG) increased its normal dividend but said it expects softer earnings in the next year. This has been a common theme for the market this reporting season.

The market has realised a 1% increase in dividend payouts whilst earnings have fallen by 1%. This may seem great for shareholders in the short term but highlights that managers haven’t been confident to invest. Citi equity strategist Tony Brennan said in the Sydney Morning Herald that “for their part, company managements haven’t been too gloomy about the outlook, although most acknowledge the uncertainty”.

Low interest rates, a weaker Aussie dollar and a strong victory at the next federal election may soon improve the economic environment in Australia and could turn the rising dividend payout trend around. Equity Trustees chief investment officer George Boubouras told SMH that “if there is a cyclical recovery in the economy, which is what a lower rate environment and a lower Aussie dollar is about, then there is going to be a bit of a change in sentiment”.

As a result stocks such as Wesfarmers (ASX: WES) and Coca-Cola Amatil might not be as attractive to investors looking for companies willing to invest and take on growth opportunities.

The willingness to search for long-term growth opportunities is paramount for businesses right around the world. In the US and Japanese markets companies yield on average around 2%-2.2% whereas our market pays around 4.7%.

Foolish takeaway

Investors searching for stocks need not only analyse the company but consider the macro cycles and trends of the market before committing to a purchase. High dividend payments might be good in the short term but shareholders need to be sure the company isn’t denying itself long-term growth prospects. Telstra (ASX: TLS) is one stock that pays dividends from cash flow and provides long term growth trends that can fit into almost any portfolio.

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Motley Fool contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies. 

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