10 top dividend stocks for 2011

This article appeared in the March 2011 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

Almost two thirds of companies increased their dividends in the latest profit reporting season - a welcome trend for income-seeking investors. This article summarises what you need to know about dividends, and outlines 10 stocks that meet Lincoln’s dividend-paying criteria. TIM LINCOLN reports.

Photo of Tim Lincoln By Tim Lincoln

The Australian sharemarket is perceived globally as dividend friendly for two reasons: our dividend imputation tax system, and the top 300 ASX Listed companies are typically more inclined than their overseas peers to pay out profits through regular dividends.

Since the Global Financial Crisis, Australian companies have increased dividends, which reflects the resumption of profit growth and confidence in the economic outlook. The trend for this reporting season is also positive, with the majority of companies raising dividends.

Here are 10 things you need to know about dividends in 2011 (later in this article we look at 10 companies that meet Lincoln’s criteria for sound dividend payers):

  1. The dividend yield is useful for determining the return on investments. It shows the dividend payment as a percentage of the price in the same way an interest rate shows a return on a deposit. (Dividend yield equals total dividend divided by share price.) Currently the yield on the Australian sharemarket is around 3.9 per cent, and the consensus analysts’ estimate is an increase to around 4.3 per cent in 2011.
  2. In 2011, to late February, of the companies to have reported results and announced dividends, more than 60 per cent have increased them.
  3. Typically, the resources sector pays a dividend yield below the broader market, because many such companies re-invest their earnings to fund projects and focus on providing shareholders with capital growth.
  4. For investors to be eligible for a dividend payment they must hold shares in a company before the ex-dividend date, which is four business days before the record or close-of-books date, unless the company specifies otherwise.
  5. If a company has paid Australian corporate tax (30 per cent) on its profits, the company will receive franking credits for the tax paid. Affectionately known as the “great Australian gift”, these credits are distributed with dividends to shareholders, who are able to claim the credits from the Australian Tax Office. As a result, a fully franked 3.5 per cent dividend yield effectively pays a shareholder 5 per cent. Typically, companies operating overseas, infrastructure and real estate trusts will issue few or no franking credits.
  6. To be eligible to receive more than $5000 of franking credits (which equates to fully franked dividends of $11,666) you must hold the shares for 45 full consecutive days (47 including the trade days when you buy and sell).
  7. A common misconception is that a company that pays a dividend is a “safe” investment. But as the GFC reminded everyone through the examples of Babcock and Brown Limited and other failed companies, and real estate trusts, that the health of a company’s balance sheet and cash flows determines whether a company is safe.
  8. Another misconception is the share price of a company that pay a high dividend does not go up. This may be true in some cases, but many have rewarded shareholders with great yields and capital growth.
  9. It is important to determine whether a company’s dividend is sustainable. Investors can look for a dividend coverage ratio above one that implies the company generates sufficient profits to pay the dividend. The dividend coverage ratio equals earnings per share divided by dividend per share.
  10. Companies are also able to distribute earnings and franking credits to shareholders through off-market share buybacks, which include a fully franked dividend component. Read the recent story learn more about share buybacks to understand how they work. Even though these buybacks are usually at a discount to the share price, they can be beneficial from a tax perspective. Companies that have recently had off-market buybacks include Woolworths Limited (WOW) and Foster’s Group Limited (FGL).

Here are 10 dividend-paying companies to consider in 2011:

(Editor’s note: Do not read the ideas below as recommendations. These are shares that meet Lincoln’s criteria; they may not suit your investment goals or risk profile. Do further research or talk to your financial adviser before acting on the information below).

  1. Euroz (EZL)
    Dividend yield 6.34 per cent, tax equivalent yield (after franking credits) 9.06 per cent.

    EZL is a financially healthy Western Australia-based stockbroker. It had a strong first-half result after strong corporate activity in Western Australia as a result of placements and capital raisings. EZL has a large cash surplus and a policy of paying out the majority of its earnings to shareholders.
  2. Bradken (BKN)
    Dividend yield 4.80 per cent, tax equivalent yield 6.86 per cent.

    BKN has had several periods of solid earnings growth through demand for the company’s mining products, as a result of the strong market for iron ore and coal. Even though the company’s first-half result was slightly below expectations, BKN reiterated previous 2010-11 guidance of 15-20 per cent growth in earnings before interest, tax, depreciation and amortisation (EBITDA). Apart from offering exposure to the mining boom, BKN is able to pay a good dividend because it trades at a relatively low price-earnings (PE) ratio of 12.4 times forecast earnings.
  3. Coca-Cola Amatil (CCL)
    Dividend yield 4.00 per cent, tax equivalent yield 5.71 per cent.

    CCL is a fundamentally healthy business known for its defensive quality of earnings. This reliable stream of earnings enables the company to pay progressive dividends while providing high single-digit profit growth year on year.
  4. SP AusNet (SPN)
    Dividend yield 9.20 per cent, tax equivalent yield 10.78 per cent.

    As a diversified energy infrastructure business, SPN provides a reliable stream of cash flows that enable it to pay a good dividend yield. Over the past year, SPN’s dividend has been franked at 40 per cent, resulting in a tax equivalent yield above 10 per cent.
  5. Commonwealth Bank of Australia (CBA)
    Dividend yield 5.61 per cent, tax equivalent yield 8.01 per cent.

    CBA delivered a strong interim result above market expectations, with better-than-expected net interest margins. Despite the strong share price run-up, CBA still offers a forecast dividend yield exceeding 6 per cent.
  6. JB Hi-Fi (JBH)
    Dividend yield 4.24 per cent, tax equivalent yield 6.06 per cent.

    Apart from having a store rollout strategy that has been very successful, JBH offers investors a solid dividend as it continues to generate strong cash flows from operations.
  7. SMS Management & Technology (SMX)
    Dividend yield 4.28 per cent, tax equivalent yield 6.11 per cent.

    SMX announced an interim result with strong revenue growth, producing one of the most impressive results in the information technology sector. SMX has usually paid a solid dividend yield and is likely to continue to do so because of its low-risk strategy, cash surplus and experienced management.
  8. Westpac Banking Corporation (WBC)
    Dividend yield 5.71 per cent, tax equivalent yield 8.16 per cent.

    WBC had a strong quarterly update, the company’s retail banking division performing reasonably well and consensus analyst earnings forecasts for the bank being upgraded. Despite the recent share price run-up, WBC offers a good dividend yield, fully franked.
  9. Legend Corporation (LGD)
    Dividend yield 5.37 per cent, tax equivalent yield 7.67 per cent.

    LGD distributes and manufactures electrical products and semiconductors. Despite a share price run-up over the past year, the company continues to deliver a fully franked dividend yield exceeding 5 per cent on the back of solid interim results, despite headwinds in the sector.
  10. GWA Group (GWA)
    Dividend yield 5.28 per cent, tax equivalent yield 7.54 per cent.

    A supplier of building fixtures and fittings to households and commercial premises, GWA has traditionally paid investors a solid dividend and with a return to earnings growth and positive outlook on the back of reconstruction work in Queensland and Victoria, this is a company that may reward in 2011 according to Lincoln’s analysis.

About the author
Tim Lincoln is managing director of Lincoln, Australia’s premier fundamental analysis research house and fund manager, offering intelligent sharemarket solutions for the conscientious investor.

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