Dividend Yields: NZX against US Markets

I think that dividend yield is one of the most important numbers to know when it comes to shares. The whole point of investing from my perspective is to get a piece of the action. The more money that comes to shareholders as opposed to executives, the better in my opinion.

The dividend yield is calculated by dividing the share price by dividend per share. Just like the price/earnings ratio, we need to be careful about making investing decisions on the basis of one ratio however.

If there’s one big difference between the NZ sharemarket and the US sharemarket (NASDAQ, NYSE…) it is the different attitudes towards dividends. New Zealand companies have very high dividend payouts relative to US companies.

What’s the reasoning behind this? I think it has a lot to do with how dividends are taxed. In New Zealand, there is an imputation credit system where dividends can be paid with imputation credits attached.In effect, this means you only need to pay extra tax on the dividend you receive if you are in the highest income tax bracket.

The story in the United States is very different. There, the company pays tax on its profits and the shareholder has to stump up again when the dividend lands in their account. This is called “double taxation”, and as a result, some companies are reluctant to pay dividends instead preferring to invest in growth or executive compensation.

An interesting exercise is to visit the great website Top Yields. Look at the NZX50 top yields and the sorts of companies appearing. Then look at the NASDAQ and NYSE top yields and the sorts of companies appearing.

In New Zealand, pretty solid performers like our banks (which despite all of their faults have been fantastic for shareholders the past decades) and retailers. In the United States, most of the top yields come from companies best described as “second tier”.

There are several theories as to why this is. For one thing, New Zealanders have more on term deposit than they do invested in shares. Since the 1987 sharemarket crash a lot of people have avoided shares and instead focused on non-productive housing investments.

There is a cultural reluctance to admit that poorly developed local capital markets mean raising finance offshore is the only way for many domestic companies to get the capital they need. In effect, our aversion to shares is making covered bond issues in Europe and dual listings on the Australian Stock Exchange far more palatable than domestic issues.

The stalling of partial asset sales, which would provide some solid new issues for the NZX, will only make the problem worse. Substantial inflows from Kiwisaver haven’t really happened. Some analysts think that all Kiwisaver has done is change where household saving is done as opposed to the actual level of household savings.

All of this is in stark contrast to the US markets. Despite the rise of high frequency trading and quantitative easing disproportionately benefiting the holders of financial assets, they have far more domestic participation in their capital markets.

That means that even when dividends are paid in the billions, the market capitalisations they are paid out against mean really low dividend yields like 2% or even less are standard.

Many US corporations are also sitting on massive cash balances offshore or domestically, not investing it in their business or returning it to shareholders. This of course makes NZ dividend yields look substantially higher than US markets.

I believe that the only reason to own shares is to get the dividends. Capital growth is a lottery and there are no guarantees that paying a premium for average businesses will be rewarded by long term growth in earnings and dividends.

For that reason, despite the almost hegemonic influence of US corporations, their policy against paying dividends and sitting on massive cash piles makes them less attractive as options.

For Kiwi investors, the Foreign Investment Funds tax regime is another tick against participating in the US markets. You could end up with a tax bill and no cash to pay it with, forcing an early sale.

Very high dividend yields can obviously be a sign that something is wrong. A company could be in the middle of a debt crisis or PR crisis. The underlying business could be uncompetitive or struggling. But for the present time, in light of NZX performance over the last year, the dividend yields in the New Zealand sharemarket are bloody good.

A lot of the risks – political, currency, volatility, adverse external shocks – are unlikely to destroy the ability of some high dividend payers to pay their dividends. For example, if the economy continues to meander through Great Depression 2.0 the profits The Warehouse Group (Dividend Yield of 9.49%) will earn are unlikely to come to an end anytime soon.