Dividend growth is set to outpace earnings growth for the fourth straight year even as fears of a "dividend bubble" grow.
Record low interest rates are fueling investors' obsession with dividends and this obsession is forcing company boards to deliver decent, if not growing payouts, at a time when earnings are under pressure.
Are dividends sustainable when consensus is forecasting distributions to grow by 4.6% and earnings are expected to grow at half that rate in 2014-15?
The short answer is "yes" although the investment strategy for income investors will need to change.
Stocks outside the resources sector shouldn't have too much trouble delivering on dividend expectations according to the latest research report by Morgan Stanley, although dividend growth is predicted to slow to under 3% in the next financial year.
This optimistic assessment of Australian dividends comes despite predictions that payout ratios (the amount of profit paid as a dividend) will hit at least a 10-year high of 73% in the current financial year compared with an average of 65%.
But the high payout ratio is not ringing any alarm bells, at least not yet, because corporate Australia has enough balance sheet flexibility from retained earnings, cost savings and low gearing, to support the generous dividend policy.
What's more, sectors that have been favored by income investors for their more dependable distributions have lower dividend risk.
This is because their current payout ratios and cash flow generation compares favorably to their longer run averages, noted the broker.
These sectors include real estate investment trusts, telecommunications, financials, healthcare and consumer staples.
The S&P/ASX 200 Index (Index:^AXJO) (ASX: XJO) is expected to yield approximately 4.5%, which is one of the highest equity yields in the world.
However, targeting blue chip stocks with the highest yields will not be a winning strategy going forward and income-seeking investors will need to look more closely at earnings growth as well as dividends.
Only those with an above market dividend yield that can generate profit growth in this uncertain economic environment can be considered safer dividend bets.
The stocks that fall into this category that are favored by Morgan Stanley include wagering company Tabcorp Holdings Limited (ASX: TAH) with a 2014-15 forecast yield (including franking) of around 5.7%, wealth manager AMP Limited (ASX: AMP) on a yield of about 5.6%, investment bank Macquarie Group Ltd (ASX: MQG) with a 4.6% distribution, investment manager Perpetual Limited (ASX: PPT) with a 6% yield, and retailer Super Retail Group Ltd (ASX: SUL) with a yield of about 6% as well.
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