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A steady dividends flow - Eureka Report article

A steady dividends flow

Scott Francis  21 January 2013

Summary: Investors in many of the largest listed companies have watched their share values deteriorate since the GFC, but they are ahead on dividend payouts, particularly when tax franking credits are added back into yield equation.

Key take-out: Australian share dividends have grown at an average rate of 1.1% a year greater than inflation.

It sounds like the riddle for the perfect asset class. Which is the investment class where returns have increased historically (over the past 110 years) a little faster than the rate of inflation, there has never been a year of negative returns, and there are tax benefits attached? The answer – the returns from sharemarket dividends.

It seems almost a shame that this income class has to be attached to the price volatility of shares, which can fall in value across the whole market by 50% or more, but perhaps the value of sharemarket dividends deserves further emphasis.

There was a thought that a ‘five to seven-year’ timeframe was suitable for investing in shares – an often quoted piece of wisdom from the financial services industry found on research reports, managed fund information sheets and in financial planning advice. It is now more than five years since the sharemarket hit its record highs toward the end of 2007, and we are still more than 35% below those levels. So we now have a clear demonstration that a five-year timeframe may not provide a positive return from investing in shares.

Of course this analysis, like much of the analysis that surrounds shares, only considers the movements in the price of shares. There is, of course, the benefit that comes from receiving dividends from the ownership of shares.  Unlike sharemarket values, which are still well down on pre GFC levels, average dividends have actually increased over the same period.

The benefits of dividends are well worth considering in the current environment – with the Reserve Bank’s target cash rate at 3%, talk of further falls in interest rates, and investors even now struggling to earn more than 5% on cash and term deposit investments. Suddenly, the potential income earned from shares appears to be comparatively attractive.

Any discussion on the income produced from investing in shares must emphasise the two benefits of sharemarket income in franking credits and dividend growth, and also point out the risk that dividend income can fall, both at the company level and across all of the shares in a market. A third benefit that investors might choose to capture is the ‘yield effect’, which shows higher-yielding shares providing an above-average return for investors. Let’s start by looking at the value of the growing income stream received from owning shares.

Growth in Income

The 2011 Credit Suisse/London Business School Global Investment Yearbook (click here) considered the role of income in influencing returns across different asset classes. It calculates that worldwide between 1900 and the start of 2011, share dividends across the world’s sharemarkets have grown at an average rate of 0.83% a year greater than inflation, and in Australia this rate has been higher at 1.1% a year greater than inflation.

As a compelling example of the way dividends grow over time, I have updated a table from a story last year (Buffett’s dividend secret) that started by assuming that a person owned the 10 biggest companies in 2002-03, owning enough of each that they received a $1,000 cash dividend in that year. Without assuming that dividends were re-invested (i.e. still owning the same number of shares as in 2002-03) it tracked the dividends that would have been received in 2007-08, the highest income-paying year leading up to the GFC. I have now updated that table to show the 2012 calendar year dividends (again assuming the same number of shares are owned as in 2002-03). It shows that dividends now across these 10 large companies (and because they are the largest, they are the companies investors are most exposed toare actually on average about 20% higher than their pre-GFC income peaks – even though shares are still down in value from their peak prices. This result surprised me, and highlights the power of income growth over time.

Dividend ($)

Dividend ($)

2012 Calendar Year
Dividends ($)









































Total Dividends




Franking Credits

Franking credits are likely to be well known to many Australian investors – being the tax benefits that are received from Australian shares. The tax benefit is there to offset the company tax already paid by the company distributing the dividends.

The tax benefit effectively reduces any other tax the owner of the shares (e.g., a self-managed super fund) might have to pay or, if no tax is owed, then the franking credits will be received as a tax refund. This is crucial – as it makes franking credits for Australian investors just as valuable as the cash part of a dividend.

The value of franking credits can be calculated by multiplying the dividend of a fully franked share by 3, and then dividing by 7. Taking the average market income of 4.3%, the value of the franking credits (if you owned 100% franked shares) would be 4.3% x 3/7, or 1.8%.

The total income would therefore be 4.3% plus 1.8%, or 6.1%. Assuming that the average franking in the market is 70%, then the franking credits are 1.3% and the total income 5.6% – far more attractive than the quoted average income of 4.3%. Interestingly very few people talk about this 5.6% as being the average market yield, referring to the cash dividend level of 4.3% as the average. In reality, for Australian investors, the 5.6% figure that includes franking credits better represents their investment experience.

Let’s go back to our model portfolio, with enough invested to earn $1,000 of cash dividends from each of the 10 biggest companies in 2002-03. The cash dividends started at $10,000 that year, and are now $20,770. Working on an assumed average franking level of 70% (in reality I would expect this portfolio to have higher franking levels), then the income would be boosted by another $6,231 of franking credits – used either to offset tax owed, or received as a franking credit.

The Yield/Value Effect

There is a body of research that suggests ‘high income paying’ companies (often referred to as value companies) perform better than those paying no income or more average levels of income. The 2011 Credit Suisse/London Business School Global Investment Yearbook pays particular attention to this phenomenon – often known as the yield effect, or value effect.

London Business School research over the period 1900 to the end of 2010 split the largest 100 London-listed shares into two groups each year – one group being the highest 50% of dividend paying shares, the other the lowest 50%. The average annual return from the lowest-yielding share group was 8% a year, and the highest-yielding group 10.9% a year.

The authors of the Global Investment Yearbook cite the yield/value effect in Australian shares (i.e., the excess return for investing in higher-income paying shares) at over 5% a year in the period 1900 to the end of 2010, and a more modest (and I would suggest realistic approximation looking forward) 2% a year in the period 2000 to the end of 2010. It should be noted that there have been periods of time – even long periods of time – when this yield effect has been negative in countries where it has been studied.

The Australian opportunity

These last two areas of discussion – franking credits and the yield/value effect – would seem to offer Australian investors a unique opportunity. Allocating some of a portfolio to higher-yielding shares (above the market average of 4.3%) that are fully franked has the possibility of enhancing returns in two ways – providing more franking credits from the higher income stream, as well as generating higher returns if the ‘yield effect’ provides a positive return.


John Burr Williams, an investment theorist from the first half of the 1900s was so inspired by the potential value of dividends in portfolios that he even wrote a little poem:

A cow for her milk,

A hen for her eggs,

And a stock by heck

For her dividends.

Shares are often discussed in terms of their price movements and capital growth or a fall in values. However, the real treasure might be their reliable income streams that offer franking credits and tend to increase over time.