If you are looking for a steady income stream from your investments then shares can be an attractive proposition. Not only do shares provide a return in the form of capital gains or losses but most shares also pay a dividend.
Traditionally, high yielding shares have been buffered from a downturn in the market. This is because dividends usually get paid regardless of whether the market rises or falls. When the market falls, dividends can act as a buffer against losses in the share price.
As an investor, you should be more concerned about after tax profit because that’s how much you have in your pockets at the end of the day.
Dividends can be a tax-effective way of receiving income. In Australia, we have a system of dividend franking.
That means that if your dividend is fully or 100% franked, the company has already paid tax on that income to 30%. So with a fully franked dividend, it comes with a tax credit. If you are on a marginal tax rate of less than 30%, you effectively end up paying no tax on that income and may even receive money back from the tax office. If you are on a marginal tax rate of greater than 30% then you usually pay the difference. With an unfranked dividend, you receive no tax credit with that income.
Dividend yields on the Australian market are starting to look very attractive.
To give you an example: Here are the dividend yields of the big four banks at the moment:
CBA yield 7.5%
WBC yield 7.4%
NAB yield 9.6%
ANZ yield 8.7%
High dividend yields are either because of increasing dividends or because of falling share prices. Unfortunately in the case of the banks, it’s been because of falling share prices.
Dividend yields are historical and you may have heard the adage that past performance is not an accurate predictor of future performance. So if you are interested in dividends from your shares, here’s a checklist of things that you should be checking.
Income investing is more than getting high dividends. It’s also about getting a sustainable dividend.
Dividend payout ratio is one way that we can measure the sustainability of dividends. It measures the dividends as a portion of earnings.
Generally a payout ratio less than 100% is desirable. Be careful of a payout ratio greater than 100% because it means that the dividend is not sustainable given the conditions which are prevailing at the time.
You need to make sure that the company you are investing in is maintaining profit or growing profit so that you can get your dividends. Often if companies get into a rough patch, they will start to cancel dividends.
You want to see forecast earnings growth as at least steady if not positive.
Be careful if you see negative earnings growth being forecast as this can be a precursor to dividend payments being reduced or cut altogether.
The great thing about income investing is that you get money whether the market is going up or whether it is going down. Hence income investing can act as a buffer against losses when the market is going down.
Income stocks tend to come into fashion in a sideways and falling market.
All in all, the sharemarket can be one of the most tax effective places to make capital and receive income. At the end of the day, you not only want income from your shares but also capital growth so don’t forget to also research the underlying company.
Happy investing!
Julia Lee Equities Analyst Bell Direct
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