A common misconception on the dividend-growth trade-off is that a high-dividend-paying company means low growth, says Paul Taylor, head of Australian equities at Fidelity.
“The only problem is the data, the research, the analysis and history tells us the complete opposite,” he says. “The bottom line is, there’s actually not that trade-off between dividend and growth.”
Taylor says it’s logical to think that a higher dividend payout ratio means less money needs to be reinvested back into a business, inhibiting growth.
“What the data shows us is that high-dividend-payout-ratio companies actually deliver higher growth than low-dividend-payout-ratio companies,” he says.
“What was found [in some] research was that [this] was happening because the high-dividend-payout-ratio companies do have a smaller amount to reinvest back into the company, but because they’ve got a smaller amount, they really make sure that they get the best returns.
“There’s a real capital discipline brought to those companies.
“So the marginal rate of reinvestment is significantly higher – they really make sure they get their 15 per-cent-plus return on invested capital.”
The findings revealed that on the other hand, companies that have a low dividend payout ratio tend to squander their money.
“They make acquisitions, they empire-build, they don’t look as closely because they’ve got a lot of money,” Taylor says.
“Money is effectively burning a hole in their pockets.
“They’re actually getting much lower marginal rates of reinvestment and much lower return on invested capital. That’s actually leading to lower growth.”
Another theory behind this conclusion is that companies with a higher dividend payout ratio are “actually signaling their confidence about the outlook for the market – the outlook for their future earnings ratio,” Taylor says.
“So if you’re willing to pay a large dividend…you feel you’re very confident about the future of your earnings, the future of your company.”
He says businesses with these characteristics have outperformed, demonstrating the extra significance of dividends in the current volatile environment.
“The really interesting thing about where we are at the moment is that as an equity investor, you’re getting paid very well in dividends,” he says.
“The dividend yield of the Australian market today is about 5.9 per cent.
“The Australian market has been the best performing market in the world long term.
“So for the last 110 years, the Australian market has generated a real annual return, adjusted for inflation, of about 7.5 per cent per year. Now on a nominal basis, that’s about 12 per cent.
“What it’s effectively telling us is that as equity investors, we get our long-term returns from the dividends we receive, plus the growth in those dividends.
“Not only have the highest-yielding markets, including Australia, delivered the best returns over all time periods, they’ve actually done it with the lowest volatility.”
