Successful investors know that “greed when others are fearful” can drive superior long term investment returns. However, this does not mean that investors should simply shut their eyes and buy when there is a significant market fall. There are factors experienced share traders assess in determining when to buy – and a stock’s dividend yield is one of the most important considerations in a low growth, low interest rate environment.
The calculation of a dividend yield is fairly straightforward. For a stock that pays dividends twice a year, take the two most recent dividends, add them together, and divide by the current share price. The result is the (dividend) annual return on the capital invested, expressed as a percentage per annum. We can then factor in any franking credits that are attached to the dividends to “gross up” the return.
Of course, investors are interested in what they will receive in the future. The forward looking dividend yield is calculated using estimates of the next two dividends.
Growth for ANZ, CBA and WBC is forecast at 3%. For NAB and Telstra, there is an assumption of no change in the dividend. I stress, these are assumptions, and future dividends could change. Nonetheless, the right hand column shows the all up return for Australian taxpayers. Many investors agree that a dividend stream from bank shares between 8.1% and 9.9% is attractive relative to bank deposit rates around 2%-3%.
It’s important to bear in mind that the risk profile of a bank share is very different to a bank deposit. While the credit exposure may be on the same company, the capital position is very different. Deposits are “capital stable”, that is, investors receive the original amount they put on deposit when the deposit is withdrawn. In contrast, share prices can fluctuate wildly – as if investors need reminding after the last couple of weeks. However, this increased capital risk can be both negative and positive, as share prices can go up as well as down.
It’s numbers like the above that entice investors into the share market even as the doomsayers are calling for the end of the (economic) world. Any investors who are not already heavily exposed to the big four banks and Telstra are looking at stronger investment cases. While this excludes most individual and SMSF investors, who are heavily exposed to these blue chips, the lower AUD is bringing more international attention to this investment theme.
At 2%, Australian interest rates are higher than the near zero levels in many countries. This makes the dividend yields on highly rated Australian shares even more attractive, especially as the AUD plumbs six year lows below 70 US cents.
This is why some analysts are making bullish calls on the share market. The investment dynamic is known as the “dividend floor”, a theoretical support level where the dividend yield on the index reaches compelling investment levels. While the bearish chorus is warning against “catching a falling knife”, others are noting an Australia 200 index yield above 5%, without calculating the additional return from attached franking credits.
A cash return greater than 5% on an index portfolio? Unless predicting an implosion, either in the Australian economy or global market sentiment, this is a number that local and global investors cannot ignore.