Finding Income With Slashed Bank Dividends
In the past fortnight ANZ and WBC have decided to defer their interim dividends due to the unknown impacts which Corona virus will have upon their businesses moving forward.
Additionally NAB, another major holding for many retirees has announced that they have decided to reduce their interim dividend by 64%. With capital losses being felt the banks as well, many income focused investors will be reconsidering their allocation toward bank equities.
While over the last decade of rising house prices, a domestic economy that was expansionary and strong bank earnings, investors could comfortably say “I own ANZ/CBA/NAB/WBC because they pay reliable and consistently large fully franked dividends.”
Unfortunately, what these investors have appeared to ultimately forget (or potentially did not consider), is that at the end of the day bank earnings, profits and ability to pay the oversized dividends that local investors have come to expect are ultimately dependant upon three simple factors:
1. Net Interest Margins: the simple difference between what a bank borrows at (including the interest it pays depositors) and what a bank lends at (loans, credit cards etc).
2. The growth of lending. The more money a bank lends, at higher interest rates, to quality borrowers results in increased profits. While towards the end of 2019, the market was disappointed at ANZ’s declining home loan market share, today in the Covid world the timing of the decline of this market share appears to be a boon.
3. The credit cycle. Through out history, credit moves in a cyclical nature with booms and busts along the way. This is the one that a lot of local investors have forgotten about during Australia’s record breaking period without a real recession. When businesses struggle, asset prices fall and borrowers struggle to meet repayment obligations, it causes bank profits to dissipate and often disappear into losses.
While our big banks (and even local regionals like BoQ and Bendigo Bank) historically have paid significant and compared to global competitors arguably excessive amounts of free cash flow and earnings back to their investors, moving forward at least over the short to medium term it appears unlikely that these high payout ratios will be able to be maintained.
The goal for many investors is to invest in a pool of assets that will generate consistent income. With traditional (and easy to access products) such as cash and term deposits paying historically low returns the pertinent question becomes “how can I generate this income?”
Many investors will start to move towards more of the traditional yield plays such as Telstra, Wesfarmers, BHP, Rio Tinto and Woolworths. This will not be an appropriate blanket strategy for all investors, in fact when investing in equities for income there is always the risk that the business has a bad year and chooses not to pay a dividend.
That is why fixed income and bonds should form the cornerstone of an income portfolio. However, there is still a way to generate long term income from the equities component of your portfolio and capitalise on the long term growth of exceptional businesses.
Rather than focus purely on the yield today, it can be beneficial for the astute and prudent investor to hone their attention to the ability of the organization to increase their dividends over time and the future yield relative to their purchase price.
The chart below shows the increase in the dividend paid by market darling CSL over time. While by traditional metrics the current yield on CSL is approximately 1.0% (depending on market fluctuations), however for the investor who purchased the stock in as recently as 2015 they are sitting on a yield of close to 3%.
When it comes time to construct your portfolio with an income focus in mind, it makes sense to hold a range of asset classes including fixed income, equities and real estate. In order to find the appropriate mix for your retire, talk to us today