Why are there no ASX dividend aristocrats?
The implications of investing in a market when no Australian companies meet the definition of a dividend aristocrat.
Mentioned: ANZ Group Holdings Ltd (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank Ltd (NAB), PepsiCo Inc (PEP), Westpac Banking Corp (WBC)
Australians have a love affair with dividends. And it isn’t surprising. Our local indexes have dividend yields that far surpass what is available in other markets. Then there are franking credits which provide another boost for Australian investors who own Australian shares.
Despite this preference for dividends and the willingness of companies to indulge this preference there is one thing missing from the local landscape. There are no ASX listed shares that are dividend aristocrats.
A dividend aristocrat is a US coined term that denotes a company that has raised dividends for the last 25 years. Not content with dabbling among the aristocrats? Perhaps the dividend kings are more your speed. Those are companies that have raised dividends for the last 50 years.
The number of companies that quality for these lists is not inconsequential. There are 67 dividend aristocrats in the US. 54 of those aristocrats qualify as dividend kings. The fact that there are no ASX listed companies that qualify as a dividend aristocrat is interesting. But it also has implications for Australian investors.
Why are there no Australian dividend aristocrats?
To pay a consistent and growing dividend requires a company to have both the will and the ability to keep the streak going. Australian companies have the willingness to pay dividends as evidenced by the high yields.
The ability to raise a dividend consistently is more difficult. I’ve outlined 4 reasons why Australian companies have not been able to maintain a long enough streak of dividend increases to qualify as a dividend aristocrat.
The dominant sectors in Australia are cyclical
Dividends are paid from earnings. To grow dividends consistently means consistently growing earnings. Consistent earnings growth is not just a function of how well a company is run. It is also based on the type of business environment the company operates within.
Cyclical companies operate in sectors where results follow the business cycle. In certain parts of the business cycle earning tend to increase. In other parts of the cycle earnings struggle. Cyclical sectors include financials, basic materials, consumer cyclical and real estate.
Simplistically we can think of the business cycle as how the economy is performing but there are other cyclical factors that impact certain sectors. Interest rate movements impact financials. Commodity prices influenced by supply and demand impact miners. The details are not important for this article but the point is that earnings tend to be less stable even if the overall direction is up over the long-term.
Defensive sectors tend to perform consistently regardless of the business cycle and other economic factors. These sectors include consumer defensive, healthcare, and utilities. No matter what is happening there are certain needs that must be fulfilled.
The other sectors sit somewhere in the middle and are somewhat sensitive to the economic cycle. These are communications services, energy, industrials, and technology.
Scanning the sector allocations of the ASX 200 and the S&P 500 shows the differences between the the Australian and US markets. The ASX 200 has a 66% allocation to cyclical sectors while the S&P 500 only has a 26% allocation. Simply put earnings in the US tend to be more stable than in Australia. This makes it easy to maintain and consistently raise dividends.
Looking at the dividend kings list shows the influence of different sectors on dividend outcomes. Of the 54 companies on the list 28 fall within defensive sectors. Another 19 fall within the somewhat economically sensitive sectors.
Dividend payout rates are higher in Australia
Sector allocations don’t tell the whole story. To consistently grow dividends does not mean a company must grow earnings every year. Every company goes through a rough patch. The ability to raise a dividend consistently is also related to the amount of earnings that are paid out in dividends.
The higher the dividend payout rate the less flexibility for a company to grow the dividend if earnings fall over the short-term. This might be a token raise but it is less likely to imperil the company’s financial health if a lower percentage of earnings go to dividend.
The ASX 200 has traditionally paid out approximately 65% of earnings in dividends. The S&P 500 pays out approximately 32% of earnings as dividends. A lower payout rate provides American companies more wiggle room to keep growing dividends even if earnings fail to grow over the short-term.
Dominant sectors are capital intensive in Australia
The well-worn adage of having to spend money to make money rings true with many Australian companies. Basic materials is the second largest sector in the ASX 200. And companies within the sector requires huge outlaws of capital to maintain or expand production.
This spending is typically cyclical and adds to the cyclicality of the sector. A mine and the associated infrastructure is expensive to establish so during periods of expansion there may be a paucity of funds for dividends. Once the mine is operating the profits pour in and dividends increase.
The other dominant sector in Australia is made up of the banks. Banking has become more capital intensive as regulations enacted since the GFC have required banks to hold more capital to reduce risk. The capital held on the balance sheet is cash that can’t go towards raising dividends. This takes a cut of loan growth as a larger loan book means more capital must be held.
The US market consists of more technology or technology enabled companies. Unlike mining these companies tend to naturally scale. The cost of creating software is spread over a larger customer base as sales rise which means a higher percentage of revenue is kept as profits. This acceleration of earnings beyond revenue growth generates huge amounts of cash. The preference of technology companies remains share buybacks over dividends but the same phenomenon of scalability can be found in the healthcare and communications sectors.
Investor expectations in Australia and the US are different
The final factor is investor expectations. Australian investors expect high dividends but are more understanding of fluctuations in dividends. Many companies in Australia set payout rates and the dividends naturally fluctuate as earnings grow and fall. This preconditions Australian investors to dividends changing year to year. It is just part of investing in the local market.
In the US a dividend cut sends a signal that a company is in trouble and causes adverse reactions from investors. Knowing that a dividend cut will likely cause the share price to plunge companies in the US only resort to a cut as a last resort. The expectations from income investors in the US is that the best companies will steadily increase dividends. As a result, companies cater to that expectation.
Why this matters
Every investor is different. For investors with a goal of generating the highest amount of income right now the Australian market has significant advantages. However, for an investor that is looking to consistently grow income the case isn’t as clear. This can include younger investors but also retirees that want income now and to grow their income stream faster than inflation.
I’ve argued in my article on building an income portfolio that most investors need both growth and high current yields in their portfolio. Ideally an investor could just buy shares or ETFs with both high yields and steady growth. But it is often a trade-off.
Companies with high dividend yields generally are unable to grow their dividends quickly. There is a debate about why we see this relationship. Some claim that high dividends are a result of management knowing there are limited opportunities for growth and returning cash to shareholders. Some claim that high dividends starve the company of cash to invest in initiatives to grow earnings. It is probably a bit of both. The more important point is that it is hard to find a high dividend that grows quickly.
Fortunately, an investor can achieve more of a balance in a portfolio. The mix of holdings can be designed to achieve both outcomes. The allocations to high yields and high growth can be adjusted based on investor circumstances.
An example is illustrative of why income investors shouldn’t ignore dividend growth. I bought shares in dividend king Pepsi (NYSE: PEP) in 2008. At the time the shares yielded a little less than 2%. This is not a share that most income investors would gravitate toward.
One place that income investors do gravitate towards is the big 4 banks. We can compare Pepsi to CBA (ASX: CBA), ANZ (ASX: ANZ), NAB (ASX: NAB) and Westpac (ASX: WBC) to see how they have faired from an income perspective since 2008.
We can compare Pepsi to ANZ on how income levels can change over time. In 2008 ANZ yielded 4.80%. A $10,000 investment would have resulted in $484 in income. Since that time the dividend has risen from $1.36 to $1.77 and the current income of the $10,000 investment is $630.
A $10,000 investment in Pepsi in 2008 would have resulted in $193.50 of income. Fast forward 16 years and things look a little different. The dividend has been increased from $1.50 to $5.40. That same $10,000 investment now results in $696.60 in income even if no dividends were reinvested.
This is not a slam dunk case for picking Pepsi over any of the big 4. While Pepsi’s dividend growth has far surpassed any of the banks the cumulative income over the 16-year period would have been significantly higher for the banks. And that is before accounting for franking credits.
Getting caught up in the nuances of my comparison is not really the point. The point is how this impacts investors and there are implications for all investors if income doesn’t grow. According to the RBA inflation has averaged 2.7% per year since 2008. That may not sound like a lot but over the 16-year period the cumulative effect of inflation has pushed the prices of goods and services 52.9% higher.
Among the big 4 banks only CBA was able to grow the dividend faster than inflation. And CBA’s dividend growth barely exceeded inflation. If an investor had purchased an equal amount of each bank the total income would have grown just over 1% a year with cumulative growth of 17.94%. A hypothetical retiree who was trying to live off bank dividends would have a big problem. Inflation adjusted spending would have to drop 30% just to maintain the same standard of living.
Buying the highest yielding shares gets an investor to an income goal faster but makes it less likely that income grows faster than inflation to increase purchasing power. In the case of the big 4 banks an investor has not even been able to maintain the same purchasing power. The longer your time horizon the more this matters.
There are several ASX listed companies that are well on their way to meeting the criteria to become an aristocrat. Dividend growth is not only available in global shares. However, many of these shares are ignored by income inestors because of their low yields. Given the high yields in Australia, on a relative sense they appear to be even less attractive. A portfolio that is balanced between income growth and current yield will yield better outcomes for most investors over the long-term.
It is informative to look at historical data to illustrate lessons for investors. But it is the future that matters. Next week I will come up with 10 share and ETF opportunities for an investor to build a balanced portfolio between income growth and high yield. In the meantime, I would love to hear your thoughts and questions at [email protected].
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