Many investors in Australian shares consider their investment to be successful if the share price has risen since they bought the shares. While capital growth is important, it’s certainly not the only reason for owning shares.
Dividend income is another significant source of return for share owners and its value is often underestimated. In fact, if share prices don’t change much, dividend income often accounts for a large part of a share investor’s return. These also tend to follow a more predictable pattern than their company’s share price.
Dividends can provide a steady flow of income for an investor to reinvest and grow their wealth or use to fund their lifestyle. For retirees and others reliant on returns from their investments, they may be a valuable source of income.
All of this makes investing in shares for their income potential an important alternative to simply considering whether their share price will go up or down.
How important are dividends to total returns?
In the last six decades, dividends have been a significant component of investors’ returns from Australian shares. On average, dividends have contributed 50 per cent to total returns over that time.
Dividends can also be more predictable than share prices. Because dividends are paid from profits, and the decision on whether and how much to pay is made by the board, there’s never a guarantee that a company will pay a dividend.
However, there are good reasons for a board to maintain or increase regular dividend payouts: it helps the company stand out from others, particularly for income-minded investors, and signals the company’s financial strength. As a result, a company’s dividends tend to follow a more predictable upward pattern than its share price.
So investing in shares for their dividend potential can deliver a fairly steady stream of income. In an environment where investors remain edgy and share markets potentially volatile, focusing on dividends may be a more reliable strategy than relying on capital growth.
The Woolies example
Woolworths Limited’s recent dividend history shows how resilient dividends can be through changing market conditions. In calendar year 2008, which covered the worst of the global financial crisis, Woolworths’ share price fell by 21.5 per cent. However, Woolworths paid its shareholders a dividend of 92 cents per share that year, 24 per cent higher than in the previous year.
So for Woolworths’ shareholders, 2008 was a great year from an income growth perspective. And the falling share price presented a good opportunity to buy more shares. Those who did have enjoyed dividends that have continued to rise steadily, while the share price has moved up and down.
The chart shows the increase in capital value of $10,000 invested in Woolworths shares since the company was listed in 1993 and the annual income (mostly dividends) on that investment.
Capital growth and income from $10,000 invested in Woolworths Limited shares
Source: MLC Investment Management, Woolworths Limited. Notes: Original investment made on 31/12/93. Assumes no change in shareholding and dividends are not reinvested. Excludes buybacks.
Tax advantages of dividend investing
For investors in Australian shares, dividend investing can also be tax-effective.
Unlike international shares, Australian shares are often partly or fully franked, which means the company has already paid tax on some or all of the dividend at the company rate of 30 per cent.
This reduces the investor’s liability for tax on the dividends.
John Owen is a portfolio specialist at MLC Investment Management
