With Aussie earnings season fast approaching, and the income-conscious eyes of many domestic investors turning towards current and future dividend policy, it seemed like an appropriate time to dig a little deeper into ASX dividends.

Today we will look to piece together a high level view of different sectors of the ASX 300 index – which sectors have the highest and most consistent “dividend spread” above pure capital gains, are there any patterns to this spread which can be timed and are there any underlying fundamentals which might have influence at an index/sector level?

The Broad Strokes

Most investors appreciate that a significant component of the investment returns offered by the domestic equity market come from dividends.

How significant a component?

Over the past 20 years, dividends represented 31% of the total returns of the ASX 300:

Here, you can see the purple line showing the true total return of the ASX 300, which includes dividends and capital appreciation. The turquoise line represents the return if an investor solely considered capital return. And finally, the “spread” represents the difference between the two – we will use this measure of spread between gross and net returns throughout this note, as a means of demonstrating the additional value dividends bring.

To put a dollar value to that example, over 20 years $10,000 becomes $70,531 and $53,615 respectively – a meaningful disparity.  And this does not take into account any benefits an individual might gain from tax optimization, like franking credits.  

Of course many investors also seek out sectors and companies specifically which offer a high dividend yield.

[Side note: We’ve written previously around our hesitancy to seek out a high dividend yield as an investment thesis, when significant evidence and research shows that growing companies will often pay more dividends in the fullness of time regardless of their yield.]

Which sectors offer the highest spread over the past two decades?

We ask readers to forgive the spaghetti chart and instead notice the persistence of these four sectors; Financials, Staples, Consumer Discretionary and Materials. These are of course some of the largest sectors in the overall benchmark, so an investor taking broad exposure to the ASX 300 would benefit from this dividend spread holistically (see the thicker green line).

The Finer Strokes

We have established the broad importance of dividends to domestic returns at a sector level – are there fundamentals which can be timed to overweight or underweight particular indexes in the context of a broader portfolio?

For purposes of a concise note, we’ll stick to two commonly used financial ratios which equity analysts tend to keep front of mind: price to book (P/B), and price to sales (P/S) – these should move quite closely together, but they act as good ‘control’s since P/S sits at the very top of the balance sheet, whilst P/B incorporates far more line items and accounting mechanics.

We can see somewhat of a relationship here that when these valuation metrics increase, that tends to lead to a tightening dividend spread – this is perhaps unsurprising given there is likely a high level of capital appreciation offsetting any gains from dividend yields.

A similar story plays out amongst the individual sectors to varying degrees, some are truly choppy and inconsistent, which leads to one obvious conclusion – it is almost certainly not worth attempting to time the dividend contribution in your portfolio.

When do dividends matter?

When do dividends matter, in our philosophy, is just like asking “when do any returns matter”?

The answer is: when the valuations justify the risk.

Although looking at the dividend spreads is interesting, in reality this is an abstraction: if you are buying for dividend income or you are buying for capital gain, the reality is that the same fundamental principles of investing should apply.

In the fullness of time, we believe that quality growing companies and well managed asset allocation will provide superior overall returns than chasing a high dividend yield company with limited prospects. But when the valuation justifies the risk, ALL returns matter, and investors shouldn’t look past the opportunity.