If you cast your mind back a few years, ASX dividend shares were normally lumped in with the ‘value’ stocks department of the ASX. Dividend shares were often some of the cheapest shares on the ASX – little prospect of significant capital growth was compensated for by high yields, making retirees and other income focused investors happy.
But things started to change when the Reserve Bank of Australia (RBA) began their current dovish cycle of easing interest rates back in early 2012. Interest rates had reached ‘emergency lows’ in the aftermath of the GFC but had slowly begun climbing again between 2009 and 2012 before the European debt crisis and sluggish domestic growth prompted the RBA to again reverse course. 2012 proved to be the highest point the cash rate reached post-GFC to date (4.75%) before the subsequent landslide of rate cuts led to the record low rate of 0.75% we see today.
What does this have to do with ASX dividends?
Well, the cash rate directly affects what kind of yield you can get from fixed-interest investments like bonds and term deposits – the main reason why a term deposit today is only slightly better than a mattress for keeping cash.
Investors who used to rely on these investments for income increasingly have to turn to dividend paying shares or property to make up the difference. Both of these investments are a lot riskier than bonds or term deposits, so the market seems to have developed a new pricing mechanism for dividend shares. Those with yields deemed ‘safest’ (commonly called ‘bond proxies’) are now commanding a significant premium on the ASX over other ‘less reliable’ dividend shares.
This (in my opinion) partly explains why the Transurban Group (ASX: TCL) share price has risen 92% over the past five years and has a current price to earnings (P/E) ratio of 220. Ditto with the Sydney Airport Holdings Pty Ltd (ASX: SYD) share price – 93.56% over the same period and a current P/E ratio of 49.
So how much should you pay for ASX dividend shares today?
If you rely on dividend income, then as long as you can lock in Transurban’s 4% yield, maybe it doesn’t matter what price you pay (as long as the traffic volume holds up in Sydney’s toll-roads). But be sure to do your research and ensure that the company’s earnings base is indeed as robust as everyone says – after all, Warren Buffett likes to say that you only get to see who’s swimming naked when the tide goes out.
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited and Transurban Group. 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 Scott Phillips.
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