Three tips for dividend investing as payouts rebound from COVID lows

Dividend payments are on the rise again as the economy reboots, but not all companies are recovering from the pandemic at the same pace. Stephen Bruce, Senior Portfolio Manager at Perennial Value Management, provides some tips for investing in the post COVID environment.

Dividend payments are on the rise as the vaccine rollout and government stimulus boosts corporate balance sheets and free cash flows.

Almost $26 billion of dividends were declared by ASX-listed companies during their first half earnings reports in February, according to research from Commonwealth Bank of Australia.

That’s up around 20% from the COVID-19-hit earnings season of August 2020, when restrictions aimed at curbing the pandemic severely impacted the revenues of many companies. In the February 2020 season, announced dividends were $27.5 billion. But over March and April, many companies reacted to the COVID crisis by shelving or cancelling dividends.

Analysts are forecasting that a continued recovery in dividends is likely as Australia benefits from soaring iron ore prices, a booming property market and elevated consumer spending.

Stephen Bruce, Director and Portfolio Manager at Perennial Value Management says dividend prospects for the 2022 financial year are strong as the economic recovery exceeds expectations.

“As COVID hit, many companies prudently reduced or cancelled their dividends. Fortunately, however, the economy is bouncing back far more strongly than people had anticipated and the lasting impacts are likely to be less than feared.”

“As a result, many companies, across a range of sectors, will be in a position to boost dividend payments in the coming year. In addition, many companies are in a strong financial position, having conserved cash or raised fresh equity as a precautionary measure.”

Buying dividend stocks (companies that have a good track of paying dividends) can be a good strategy for investors who want to generate income or build wealth by reinvesting dividend payments. It can also appeal to investors seeking lower-risk investments because stocks that pay dividends tend to be less volatile.

However, income investors who had their dividends cut or put on hold during the pandemic may be wary about how to approach dividend investing from here. Meanwhile, the impact of the pandemic has varied significantly across sectors and the pace of the recovery may be varied as well, posing new challenges for investors. So how should investors approach dividend stocks in the current environment?

Don’t get tricked by a high dividend yield.

Perennial’s Bruce says it’s important to remember at the outset that the same rules apply when investing with a focus on dividends as when investing for any other reason.

“You need to be sure you are investing in a company with a sustainable business which can grow earnings over time and not be lured into a value trap by a seemingly attractive dividend yield,” he says.

“Key areas for investors to focus on are the long-term outlook for the industry, the quality of management and the strength of the balance sheet. The last point is particularly important, with the over-geared balance sheet being not only the natural enemy of the dividend, but potentially a cause of significant capital loss.”

Look for opportunities in value stocks.

Bruce notes that in the post COVID environment, we are likely to continue to see a broadening of economic growth across a wide range of sectors, increasing inflation, and increases in interest rates from their current historically low levels. All of this should continue to drive an ongoing rotation from expensive growth stocks towards the better value, cyclical parts of the market.

“Fortunately for dividend-seeking investors, it is these more cyclical parts of the market which are also offering the most attractive dividend opportunities at present,” he says.

“By contrast, “expensive defensive” stocks such as those in the infrastructure sector, face headwinds from rising interest rates given their highly-geared structures. These sorts of stocks have been popular with many income-focussed investors in recent years due to their perceived stability but may struggle in a rising rate environment.”  

Consider the banks and resources stocks.

In particular, the outlook for dividends continues to be “very strong” for the resources sector, where commodity prices remain high, cash flows are strong, and balance sheets have low levels of debt, Bruce says.  

The outlook for the major banks – long a key source of dividends in the Australian market – is similarly positive.

“Credit growth is picking up, margins are stabilising, and the strength of the economic recovery means banks are significantly over-provisioned. Combine this with strong capital positions and the outlook for bank dividend growth is strong,” Bruce says.