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Dividend sustainability in 2013

Christine St Anne  |  25 Jan 2013Text size  Decrease  Increase  |  

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Christine St Anne is Morningstar's online editor.

 

Defensive stocks that pay good dividends were among the stellar performers of 2012 as investors continued their search for yield. With interest rates expected to fall further, dividend yields will remain a focus for 2013.

Morningstar's recent article, 6 key investment themes for 2013, highlighted dividend sustainability as a top priority for investors and companies amid tough economic and market conditions.

However, high-paying dividend stock Metcash (MTS) is already under pressure. It was only in late November when the retailer announced a 13 per cent fall in its half-year net profit. The profit number raised questions about whether the company had the capacity to maintain its dividends.

But investors need to understand there is more to achieving good returns than simply chasing high-yielding companies, Tyndall Asset Management head of Australian equities Bob Van Munster says.

"The dividend yield is a function of the stock's dividend and its price. A high dividend yield could simply indicate the stock is cheap, and cheap for a reason," Van Munster says.

 

The illusion of high dividends

"For instance, deteriorating businesses can often have a high dividend yield that proves to be an illusion. Therefore, picking the highest-yielding stocks without conducting due diligence can lead to substantial underperformance," he says.

To determine whether a stock is good value or just a trap, Van Munster says investors need to look at the underlying health of a company and the sector it operates in.

To delve further into the headline dividend yield, investment manager Tyndall adopts an intrinsic value process. This process ascertains whether the dividend yield is in fact sustainable and whether the company does have earnings and capital growth.

"The strength of a company's balance sheet, particularly gearing levels, as well as franking levels, payout ratios, potential for share buybacks and special dividends, are all keys to assessing the sustainability of a company's dividend," Van Munster says.

Similarly, Platypus chief investment officer Don Williams looks at a number of factors when determining the dividend sustainability of a company. He looks at payout ratio levels and cash flows.

"Companies with high (but sustainable) payout ratios tell us that they are very disciplined in capital management. Companies with an increasing payout ratio also tell us that they are generating both cash and earnings. These companies are the ones you can trust," Williams says.