Written by John Owen, Portfolio Specialist, MLC ‘Dividend income is a significant source of return for share investors and its importance is often underestimated.’

Written by John Owen, Portfolio Specialist, MLC

‘Dividend income is a significant source of return for share investors and its importance is often underestimated.’

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. Dividends 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 prices 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.

As the table below shows, in the 1970s, 85% of the return was dividends. In the most recent decade, dividend income still accounted for just over half of the return from Australian shares. The lowest contribution from dividends was in the 1980s but at 28%, it was still significant. On average, over the last 60 years, dividends have contributed 50% to the total return from Australian shares.

March 2013

Investment newsDividend investing: why there’s more to shares than price

  All Ordinaries Index total return

All Ordinaries Index total capital return

Contribution of dividends to

total return

1950s 15.3% 8.1% 47.0%

1960s 14.0% 7.7% 45.0%

1970s 8.6% 1.2% 85.0%

1980s 17.7% 12.7% 28.0%

1990s 10.6% 6.2% 41.0%

2000s 7.9% 3.4% 57.0%

Source: Maple-Brown Abbott Limited, IRESS.

Dividends can 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.

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%. However, Woolworths paid its shareholders a dividend of 92 cents per share that year, 24% 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 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 above shows the increase in capital value of $10,000 invested in Woolworths’ shares since the company was listed in 1993 and the annual income on that investment.

Investment newsDividend investing: why there’s more to shares than price

Capital growth and income from $10,000 invested in Woolworths Limited shares

Source: MLC Investment Management, Woolworths LimitedNotes: Original investment made on 31 December 1993. Assumes no change in shareholdings and dividends are not reinvested. Excludes buybacks.

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Dividend investing: why there’s more to shares than price Investment news

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%. This reduces the investor’s liability for tax on the dividends.

A fund focussed on growing income

MLC IncomeBuilder is designed for investors who want to access the dividend growth potential of the Australian share market. Established in 1995, the fund’s main objective is to provide a growing, tax-effective income stream to investors. It does this by making long-term investments in companies which have the potential to deliver increasing income over time.

MLC IncomeBuilder has a strong track record of delivering a rising income stream to investors over the last 17 years.