I recently wrote about total return. How much do investors actually end up taking home at the end of the day after investing in stocks?

Theoretically, with a $100,000 initial investment and $1,000 additional investments every month, in 20 years (with returns reinvested), I would have $1,391,009 (assuming a 10% p.a. return).

This is what you actually come out with.

Total return table

Figure: the components of a total return.

One of the saving graces is franking credits. It is a sigh of relief for investors. Over a long time horizon, a meaningful contribution to total returns.

In the above example, the tax rate on average income is assumed – 32.5% (plus a 2% Medicare levy.) However, at the start of the next financial year, this is going to change.

Current marginal tax rate:

Chart 1

Proposed marginal tax rates (from 1 July 2024): 

Proposed marginal tax rates

Stage 3 tax cuts and a net 0% tax rate for dividends

The tax cuts mean that the median income sits at a 30% tax rate. Most incomes – between $45,001 and $135,000 - sit in the 30% tax rate.

Fully franked dividends provide a 30% tax credit.

That is a dividend which requires a payment of 0% in personal income tax.

No investment decisions should be based on how much tax you can save. However, it is important for investors to think about that total return table. Every line item (bar franking credits) detracts from the return that you earn.

For income investors, franking credits are a welcome respite from the tax rates.

Here are three, five-star^ stocks with fully franked dividends (at 2 April 2024).

Woodside Energy WDS ★ ★ ★ ★ ★

Fair value: $45 (32% discount at 2 April)
Moat: None
Uncertainty rating: Medium

As Australia's premier oil player, Woodside Petroleum's operations encompass liquid natural gas, natural gas, condensate and crude oil. However, LNG interests in the North West Shelf Joint Venture, or NWS/JV, and Pluto offshore Western Australia are the mainstay, and the low-cost advantage of these assets form the foundation for Woodside. Future LNG development, particularly relating to the Pluto project, encompasses a large percentage of this company's intrinsic value.

Woodside is unique among Australian energy companies in that it has successfully managed the development of LNG projects for more than 25 years—unparalleled domestic experience at a complicated and expensive task. Adding to Woodside's competitive advantages are the long-term 20-year off-take agreements with the who's who of Asia's blue chip energy utilities, such as Tokyo Electric, Kansai Electric, Chubu Electric, and Osaka Gas. These help ensure sufficient project financing during development and should bring stability to Woodside's cash flows once projects are complete.

Woodside's development pipeline is deep, enabling it to leverage the tried and trusted project-delivery platform as a template for other world-class gas accumulations off the north-west coast of Australia. Woodside is well suited to the development challenge. With extensive experience, it remains a stand-out energy investment at the right price. Gas is the fastest growing primary energy market behind coal, and the seaborne-traded LNG portion of that gas market grows faster still. China is building several import terminals, and so demand is likely to pick up, helping to move LNG pricing toward oil parity on an energy-equivalent basis.

In terms of dividends, our analysts do consider it somewhat high. Woodside has had an 80% payout ratio since 2013 while LNG expansion plans have been on hold. The official policy is to maintain a minimum 50% payout of underlying earnings. It is considered an appropriate capital allocation decision to distribute funds as dividends if you’re not investing in the business. However, our analysts believe that it would be better utilized to accelerate growth plans, expanding countercyclically, taking advantage of reduced capital costs. Regardless of this, Woodside have strong cashflow and a healthy balance sheet that should support ongoing dividend payments that are 100% franked.

Healius HLS ★ ★ ★ ★ ★

Fair value: $3.00 (57% discount at 4 April 2024)

Moat: None

Uncertainty rating: Medium

Healius is Australia’s second-largest pathology provider and third-largest diagnostic imaging provider. Pathology and imaging revenue is almost entirely earned via the public health Medicare system. Healius typically earns approximately 75% of revenue from pathology and 25% from diagnostic imaging.

Despite Healius having sizable market shares in Australian pathology and diagnostic imaging, its inability to set prices and weaker market position relative to Sonic Healthcare prevent it from digging an economic moat sourced from cost advantages. Revenue in pathology and imaging is earned via direct reimbursement from Medicare at fixed fee per service rates. Healius neither currently earns a return on invested capital above its cost of capital, nor do we expect it to in a typical year over our forecast period.

Our $3.00 fair value estimate for Healius factors in 5% group revenue growth in a typical year and a midcycle operating margin of 14%. Our estimates deliver earnings per share (“EPS”) growth of roughly 9% in a typical year. The pathology segment is the primary earnings driver.

We forecast a ten-year pathology revenue compound average growth rate (“CAGR”) of 4% and expect segment earnings before interest and taxes (“EBIT”) margins to expand to 14% by fiscal 2033 from 7% in second-half fiscal 2023 on operating leverage, improved mix, and productivity improvements.

Our 4% revenue CAGR is made up of 3% volume growth due to population factors and volume growth per capita and 1% average fee increases due to a mix shift to more complex tests such as veterinary and gene-testing. We do not factor in reimbursement pricing pressure in our base case.

Diagnostic imaging revenue is forecast to grow at an 8% CAGR over the 10 years to fiscal 2033 from a combination of organic volume growth and indexation of fees. We forecast EBIT margins to expand to 14% by fiscal 2033 from 10% in second-half fiscal 2023 through network optimization, customer digitisation and exposure to higher-margin imaging modalities increasing.

The dividend when paid is fully franked. 

Integral Diagnostics Ltd IDX ★ ★ ★ ★ ★

Fair value: $3.60 (37% discount at 2 April 2024)
Moat: None
Uncertainty rating: Medium

Integral diagnostics is a leading radiologist and diagnostic imaging provider with 67 clinics operating around Australia. Integral’s strategy centres on capitalising on the growing demand for diagnostic imaging. Volume growth is driven by population growth, ageing demographics, higher incidence of diseases, and wider adoption of preventative diagnostics. These drivers are often greater in regional areas which Integral focuses on.

While the Australian government placed a freeze on Medicare fee rates for diagnostic imaging in 2013, it resumed indexation in fiscal 2022. The majority of group revenue is earned from the public health Medicare system via bulk billing, but Integral still pushes price increases selectively which raises a patient’s out-of-pocket fee for certain services. The industry is also seeing a shift toward higher value services such as MRI and PET scans which support average fee increases. This has been a key investment area for Integral, and Morningstar’s analysts estimate more than a quarter of group revenue stems from these two services.

To attract patients and build relationships with referrers, Integral seeks to differentiate itself on service levels and accessibility. Service levels rely on Integral’s ability to attract and retain high quality radiologists. Accessibility is based on sufficient capacity in convenient locations. To expand capacity, Integral either upgrades or adds machines at existing sites, or establishes new sites. Higher utilisation at clinics results in a lower cost per scan as labour, equipment, leases and overhead costs are all leveraged.

Integral’s success is evidenced by achieving an additional 2% on average in organic growth over the last five years versus the market. Growth is also aided by acquisitions, with synergies from procurement and IT being relatively easy to capture.

Shareholder distributions, which have typically averaged about 75% of underlying net income, are appropriate according to our analysts. Integral has maintained a fairly consistent payout ratio while also funding its growth, both organically and through acquisitions, as well as building its IT infrastructure and imaging equipment.


^ What do the different star ratings designations mean?

5 stars indicates an investment idea with a high probability of significant risk-adjusted appreciation from the current market price during a multi-year time frame. Scenario analysis developed by our analysts indicates that the current market price represents an excessively pessimistic outlook, limiting downside risk and maximizing upside potential.

4 stars indicates that appreciation beyond a fair risk-adjusted return is likely.

3 stars indicates that investors are likely to receive a fair risk-adjusted return (approximately cost of equity).

2 stars indicates that investors are likely to receive a less than fair risk-adjusted return and should consider directing their capital elsewhere, in our opinion.

1 star indicates a high probability of undesirable risk-adjusted returns from the current market price over a multi-year time frame. Our scenario analysis indicates the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.