With no sign of interest rate rises, and term deposit rates barely keeping up with inflation at less than 2%, income-oriented investors still find themselves drawn to the share market, where the average grossed-up dividend yield is more than 4% – with plenty of stocks “offering” yields quite a bit higher than that. (The caveat, of course, is that dividends are wholly at the discretion of the company, and can be cut, or dispensed with altogether, if the financial circumstances dictate. But while dividends can never be considered as guaranteed, they can be a very handy generator of income for a portfolio, especially when the turbo-charging impact of franking credits is considered.)
What income-oriented investors need to look for is companies that have the free cash flow to back their dividends comfortably, and also, which have a payout ratio (proportion of the net profit that is paid-out in dividends) that does not put pressure on them to crimp the dividend if there are competing priorities for cash, such as reinvestment. Across the Australian Securities Exchange (ASX), the dividend payout ratio currently averages about 70%, according to AMP Capital, so we want to see companies with a lower ratio than that, which means they can be considered to be on the safer side – even with the ever-present volatility of company earnings.
In contrast, many of the top dividend payers on the Australian stock market have payout ratios that have edged up to about 85% – and even higher – so there is very little room for disappointment in terms of a lowered dividend.