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Will old school LICs like AFIC be forced to cut their dividends?

Is it possible that old school listed investment companies (LICs) like Australian Foundation Investment Co.Ltd. (ASX: AFI) will be forced to cut their dividends?

Businesses that operate in a company structure generally have a lot of flexibility to decide how much of a dividend to pay to their shareholders each year.

AFIC has been and continues to be an excellent dividend payer for shareholders. Indeed, its shareholders haven’t seen their dividends cut this century. Many other older LICs and other companies can’t say the same thing.

Except for FY19, which included bumper dividends from resource businesses and special dividends from many other businesses, AFIC has generally been paying out almost all of its earnings each year as a dividend.

With the big ASX banks of Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd (ASX: NAB) being a big part of AFIC’s holdings, you could say that the dividends play a sizeable part in AFIC’s own dividend payments.

The trouble is that both Westpac and NAB reduced their dividends by mid-teen percentage amounts meaning less cash flowing to AFIC. APRA Chairman Wayne Byres warned today, according to the AFR, that banks may need to lower their dividend payout ratios. He said:

“When returns have been very high as they have been historically, it’s easy to both grow the business, grow the balance sheet and pay out returns to shareholders. We are entering into an environment now where that’s no longer going to be the case.

“There will be much, much harsher choice for bank boards to make about how much of their reduced returns they need to retain to grow their balance sheets and fund balance sheet growth, and how much they can afford to return to shareholders.”

If the banks do indeed cut their dividends further then unless it’s replaced by just as good (if not better) share price growth from the banks then AFIC and other old LICs may see their profit reserves being whittled away if they maintain the current payment levels.

There are a lot of ifs and maybes with this. If I were AFIC I would be focusing more on the businesses a bit further down the market capitalisation list which are growing their earnings, dividend and share price over the long-term.

Foolish takeaway

AFIC currently has an ordinary grossed-up dividend yield of 5%. The current AFIC share price or yield does not tempt me to buy shares today, I prefer buying things at an attractive discount to their value.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of National Australia Bank Limited. 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.