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Dividends – what lies beneath?

Nathan Lear
Partner/Private Client Adviser
5 Sep 2011

When making investment decisions, income yield is undoubtedly an extremely important consideration for most investors, but it’s also one of the biggest investment traps. Here’s why:

Telstra and BHP Billiton are two well-known Australian stocks. Telco giant, Telstra, is known for providing investors with a high, fully-franked dividend yield, currently around 13% fully franked. While diversified miner, BHP pays a much lower dividend of 3% fully franked and has more of a growth focus.

If you had invested a sum of money into both BHP and Telstra 10 years ago, you would have expected Telstra to have provided you with a greater level of income, right?  We all know that BHP has experienced phenomenal growth over the past 10 years – but surely Telstra would have given you more income?

Well in fact the answer is no!

Let’s assume that you invested $10,000 into both BHP and Telstra around 10 years ago (January 2002). Over this period, Telstra would have provided the investor with a total income return of around $6,400 including franking credits. However, if at the same time you have invested $10,000 into BHP, it would have yielded a total income return of around $8,700.

The following table illustrates the last 10 years of dividend returns for both BHP and Telstra assuming a $10,000 investment:       

As you can see above, while Telstra would have initially generated a higher income return in the first few years, the strong earnings and share price appreciation of BHP over time results in a higher total dollar return over the last 10 year period.

This example shows that a higher dividend yield is not always a true indication of higher profits. BHP is a more growth-orientated company and retains profits to grow earnings, whereas Telstra pays out the majority of its earnings as dividends.

The above case study demonstrates a classic investment trap – that is, not to make an investment decision based solely on income return. While yield is extremely important for investors, a balanced portfolio should consider a blend of both income and growth stocks.  

Hewison Private Wealth is a Melbourne based independent financial planning firm. Our financial advisers are highly qualified wealth managers and specialise in self managed super funds (SMSF), financial planning, retirement planning advice and investment portfolio management. If you would like to speak to a financial adviser on how you can secure your financial future please contact us 03 8548 4800, email info@hewison.com.au or visit www.hewison.com.auPlease note: The advice provided above is general information only and individuals should seek specialised advice from a qualified financial advisor. The views in this blog are those of the individual and may not represent the general opinion of the firm. Please contact Hewison Private Wealth for more information.