Dividends are one of the great benefits of holding shares. A form of passive income that helps boost investment returns, dividends not only benefit income investors but assist growth investors to grow their overall portfolio.
The reason most people participate in ownership of companies is in anticipation of sharing in company profits. Dividends are the share of company profits paid out to shareholders. Dividends provide a passive income stream which shareholders can utilise as they see fit.
Benefits of dividends
Dividends come in the form of cash, so provide a periodic actual, realised return on your investment. Capital gains are the other form of return on shares. To realise capital gains, however, shares must be sold. Capital gains can also disappear where the share price falls.
There are tax advantages associated with receiving dividends. Franked dividends come with tax credits attached, which means investors receive a rebate for tax already paid by the company on profits distributed as dividends. If your tax rate is less than the company tax rate you will receive a refund.
Reinvesting dividends is a quick and easy way to grow your portfolio. When looking to grow your portfolio or accumulate assets, dividends can be set aside to reinvest in new or existing investment options. Many companies and ETFs offer dividend reinvestment programs which will automatically reinvest distributions in that company or ETF.
How to find dividends
Company profits can either be paid out as dividends or reinvested in the company in the hope of spurring future growth. Generally, mature, lower growth companies are in a better position to pay out a higher proportion of profits than smaller, higher growth companies.
Companies in stable industries with predictable cashflows are generally better positioned to pay reliable dividends. Companies in emerging or cyclical industries are less likely to be able to sustain a high level of dividends. Banks, utilities providers, and real estate investment trusts have all been known for dependable dividend income.
A company's dividend yield is its annual dividend divided by the share price. It represents the dividend-only return on the investment in the share. When dividends remain the same, the dividend yield on a share will rise when the share price falls and fall when the share price rises. For example, Westpac Banking Corp (ASX: WBC)'s dividend yield has risen to over 7% following the recent fall in its share price.
A company's payout ratio shows the percentage of the company's earnings that are paid out to shareholders as dividends. It is calculated by dividing the total dividends paid over a period by the company's earnings over that period. The payout ratio can indicate how sustainable a company's dividend payments are.
A low payout ratio indicates a company is reinvesting most of its earnings into its business to spur future growth. A high payout ratio indicates that the opposite is true. Different industries tend to have different payout ratios. Defensive industries with stable income flows such as telecommunications and utilities tend to have higher payout ratios. AGL Energy Limited (ASX: AGL) has a target payout ratio of 75%. Industries with fluctuating cash flows or in cyclical sectors such as resources tend to have lower payout ratios.
Dividend shares
The big banks have traditionally been known for dividends but have faced difficult conditions since the Royal Commission. Here's a closer look at a few of Australian's biggest dividend players.
National Australian Bank Ltd (ASX: NAB) is yielding 6.63% and paid dividends of $1.66 per share in 2019, fully franked. In May, NAB cut its interim dividend to from 99 cents to 83 cents, concluding that 99 cents was not sustainable. The bank continues to grapple with weak conditions and higher than expected customer remediation costs.
Australia and New Zealand Banking Group Ltd (ASX: ANZ) is yielding 6.61% and paid dividends of $1.60 per share in 2019. Although the bank did not cut dividends, it cut franking credits on the final dividend of 80 cents, which was only 70% franked.
AGL Energy Limited (ASX: AGL) is yielding 5.94% and paid dividends of $1.19 per share in 2019, which were 80% franked. AGL targets a payout ratio of approximately 75% of underlying profit after tax where a minimum franking level of 80% can be maintained.
Rio Tinto Ltd (ASX: RIO) paid dividends of 307.58 cents per share in 2019, fully franked. Other than 2016, Rio has increased its dividend every year since 2010 and currently has a dividend yield of 4.24%. Rio boasted record interim returns in the first half of calendar 2019, bolstered by strong iron ore prices. The share price has declined along with the iron ore price, from a peak of $107 in July down to around $96.53 currently, boosting the dividend yield.
Whitehaven Coal Ltd (ASX: WHC) is currently trading at $3.oo, yielding 9.33%. The coal producer boosted full year dividends by 25% this year after strong coal prices led to Whitehaven's highest ever underlying profit. Dividends of 50 cents per share were paid to Whitehaven shareholders during fiscal 2019.
Yancoal Australia Ltd (ASX: YAL) is currently trading at $2.99 and has a dividend yield of 8.80%. Yancoal paid dividends of 38.9 cents per share in 2019. Yancoal, however, has only been paying dividends for a couple of years so it may be too early to consider this a reliable dividend paying stock.
Adelaide Brighton Ltd (ASX: ABC) is currently trading at $3.30 with a dividend yield of 6.07%. The materials manufacturer paid dividends of 15 cents a share, fully franked, in 2019. Shares in Australia's largest cement maker tumbled 18% as profit forecasts were downgraded by around 25% in July. Adelaide Brighton cut their interim dividend this year amid worsening conditions in civil and residential construction. The lack of interim dividend allows the company to maintain balance sheet flexibility for reinvestment in the business and to pursue growth opportunities.
Foolish takeaway
Dividends represent a tangible return on share investments. Whether used to fund current lifestyle needs or fuel future portfolio growth, dividends serve a crucial purpose in portfolio construction. Identifying shares that will consistently pay decent dividends is easier said than done. This is why diversifying sources of dividend income is crucial to lowering the overall volatility of dividend returns on a portfolio.
