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Why dividend loving investors are in for a rude shock

Income-seeking investors have had a great run over the past few years with companies focused on boosting their dividends to keep shareholders happy. The big lift in payouts is funded through aggressive cost cutting and holding back on investing for growth as the uncertain economic environment made managers risk averse.

But the dividend growth party is coming to an end as companies are increasingly confident enough to start channelling cash into growing their business. This surge in capital expenditure (capex) is happening faster than what many investors are expecting.

In fact Credit Suisse is forecasting capex to jump by $9 billion by June 2018 for the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index excluding financials, but dividends to only increase a paltry $1 billion.

“Rising capex will hopefully support growth in the future, but it does so at the expense of dividends now,” warns the broker.

While some companies will have limited scope to lift dividends, others might have to reduce them to chase growth. Those most vulnerable to a dividend cut have very high dividend payout ratios (typically above 80%) and high net debt to equity ratios.

It’s those with high debt levels that I would be warier of. As interest rates rise, they may be compelled to use their cash to repay debt instead of using it for dividends or growth.

While rising capex is not good news for income investors, it is a positive for growth seeking investors. I believe growth stocks will outperform high dividend stocks over the next 12 months, if not beyond.

But can you have your cake and eat it? The answer may be “yes” as there are stocks that are well placed to grow earnings and their dividends.

These are companies that are generate most of their income from other businesses.

As capex increases, these companies should benefit from an increase in revenue, and that in turn could give them greater flexibility when it comes to increasing their dividend payouts.

According to Credit Suisse, those in this camp include share registry services group Computershare Limited (ASX: CPU), investment bank Macquarie Group Ltd (ASX: MQG) and advertising group WPP Aunz Ltd (ASX: WPP).

Another group that is worth looking at are those that are well placed to growth both their capex and dividend. According to Credit Suisse, such stocks have consistently outperformed the broader market and some examples include mining giant BHP Billiton Limited (ASX: BHP), blood products group CSL Limited (ASX: CSL) and satellite company Speedcast International Ltd (ASX: SDA).

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Macquarie Group Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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