Watch Dividends, Not The Bubbles

The Age

Saturday February 17, 2007

Annette Sampson

WHEN morning radio starts featuring stories on the resurgence of the day trader, it's usually a sign to be afraid. Very afraid. Like the elevator boys of old, hearing novice day traders brag about their stock picks is a sure signal that the market is entering bubble territory.

Or is it?

The problem - if you can call it that - is that unlike many previous share booms, the latest bull market is no irrational exuberance where enthusiasm has taken leave of economic reality. Share prices have risen on the back of strong rises in company profits and a healthy economy.

Price-earnings multiples are certainly not low, especially for many industrial companies. But on historical levels, they're not unduly expensive either.

Analysis by AMP Capital Investors chief economist Dr Shane Oliver shows company profits have risen 20 per cent a year for the past four years - which accounts for much of the recent growth in share prices. Over the past year, he says, earnings and share prices rose by about 17 per cent. Contrast that with the 12 months before the 1987 crash, when shares rose 90 per cent while earnings rose 25 per cent.

In the latest boom, share price growth has been accompanied by a healthy rise in dividends. Oliver says the yield on Australian shares, grossed up to take account of franking credits, is about 4.9 per cent, only one percentage point below the 10-year bond yield and still well above the 3.2 per cent gross yield on rental housing.

Without adjusting for franking credits, the market's dividend yield of 3.6 per cent still compares favourably with the 2.5 per cent yield before the 1987 crash. Better still, says Oliver, the Australian market's real yield (after inflation) is still positive at 0.3 per cent.

In 1987, inflation was much higher and the real yield was negative, at minus 6 per cent. Unfortunately, it's all too easy when prices are booming to discount the importance of dividends.

However, analysis by Centric Wealth head of research James Foot shows that over the long term, dividends are much more important than fads and sentiment in determining sharemarket returns.

Foot looked at Australian shares and dividends from December 31, 1919 (the earliest date at which he says data is reliable) to December 31, 2006. During this period, share prices increased by 247 times. Dividends increased 246 times.

This shows how closely share prices and dividends have tracked one another over this period. Periods where share prices grew faster than the underlying dividends were invariably followed by corrections to bring the two back into line.

Foot's research also shows dividends can play an important role in reducing volatility in portfolios. On average, he says, share prices deviated by 16.2 per cent a year during this period - double the 7.9 per cent annual deviation in dividends. Dividend income proved remarkably resilient.

In the worst year studied, 1930, Foot says share prices fell 33.9 per cent; dividends fell 19.5 per cent.

In 1987, while share prices ended the year down 10.5 per cent, dividends actually rose by 35.7 per cent. And more recently, 2002's 12.1 per cent fall in share prices was accompanied by a 9.2 per cent rise in dividend income.

The message, says Foot, is simple. Long-term investors should focus on increasing income from their shares and let growth look after itself.

© 2007 The Age

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