Investors looking to grow income from dividends must adjust their focus and concentrate on the quality of the company and the sustainability of dividends not the payout ratio, according to investment manager Martin Currie Australia, a Legg Mason affiliate.
Leading active equity manager Martin Currie has consistently found that payout ratios are a very poor indicator of future dividends, and what is far more important is dividend sustainability and the quality (strength) of each company.
Major holdings in the Martin Currie Australian Equity Income Trust include AGL Energy, Westpac, Insurance Australia Group, Wesfarmers, Commonwealth Bank, Woolworths, ANZ, DUET Group, Tatts and ASX Ltd.
Martin Currie divides the companies in its Australian stock universe into quintiles, based on a number of qualitative factors. These include business and balance sheet strength, management quality, earnings and shareholder returns, and the handling of environmental, social and governance issues.
Companies in the highest quality quintile increased their dividends significantly in the 12 months prior to February 2017.
Martin Currie Chief Investment Officer Reece Birtles says the best predictor of dividend growth is to avoid low quality or high-risk companies.
“When you invest in high-risk companies you get dividend cuts,” Birtles says.
“Our whole investment approach is focused on uncovering high quality business models that have solid dividend-paying prospects through the business cycle, but with lower risk than the broader equity market.
“Generally, companies that have solid earnings can sustain dividend payouts and are, as a result, likely to be less volatile than other stocks.”
Birtles says the interim reporting season was a “good one” for the Australian market when compared to those over the last few years.
Birtles says the overall revenue and margin outlook for the 2016/17 financial year is positive but there will be some changes to the mix.
He sees industrials as a big improver, benefiting from improved business confidence and employment markets. Consumer staples should benefit from a more inflationary environment by retaining some price increases.
Birtles also see a much better environment for value-type stocks as they are more dependent on the economic growth cycle than growth or quality type stocks tend to be.
In order to fully capture these themes, Martin Currie’s value portfolio is overweight consumer staples, non-bank financials, utilities, and metals & mining. Its biggest underweight is banks given the growing risks facing the sector. It is also underweight low volatility sectors like healthcare, and telecommunication services.
At a more macro level, Martin Currie sees rising commodity prices contributing to Australia’s nominal GDP growth rate, which could rise to more than six per cent this year, putting more money in the system and fuelling revenue growth in the Australia equity market generally.
“Consensus revenue expectations are for companies to grow revenue by three to five per cent this year, well above the two to three per cent in 2016, but below the historical levels of five to six per cent. We think the situation should only get better as faster revenue growth and strong recent cash flow will lead to improved profit margins.”