Mark LaMonica: James, for a long time, the formula for income investors in Australia was to buy the banks. You recently wrote an article that says perhaps that’s not a good approach going forward. So I guess let’s start with just your premise. Why do you think the banks are not necessarily the place that investors should go for income?
James Gruber: Well, I’m not saying they shouldn’t, but I think they probably need less exposure on that front because as you say, people just have relied on it for decades that the banks are there for yield, for growing yield over time, and they’re very dependable with regards to that. But the issue is a fewfold in that their prices have gone up so much that you’re paying a lot more for that yield now. Also, they’re not growing earnings much at all, and therefore you’re unlikely to get growth in the dividend over time, which is a big issue. And the current yields right now are pretty low compared to history. So CBA, for instance, is yielding 2.9%, which is pretty low and below the market. Some of the other banks are in the 4s, but not that much higher compared to especially the history. So you’re not getting a lot of bang for your buck or as much as you have done in the past with the banks. And I think the big problem is, is the future? Are they going to grow earnings over the next decade and their dividends in a way that you can get some nice income growth? And I’m not sure you will.
LaMonica: That does obviously from an income investor perspective sound like the worst of all possible worlds, lower yields and no growth. Let’s talk about the ASX in general, because obviously this is something that investors are trying to achieve in their portfolios, income. What do you think about the overall market? Australia has always been a great place to invest in for income. It’s typically been a higher yield than you get in many other markets. But I guess what do you think overall about Australia?
Gruber: Well, right now the yield on the ASX is near 25 year lows. It’s at 3.5%. So it is quite low compared to ever since 2000. So you’re not getting as much yield. Part of the problem is, is that earnings aren’t growing much overall. They’re pretty flat year on year. Also, companies are paying out less dividends. So the dividend payout ratio for the 2024 financial year ended in June was 53%, which is the lowest it’s been for some time. It was in the 70s, not too long ago. So not only are earnings not growing much, but then they’re paying out less of those earnings as dividends. So that’s part of the reason why the yield is low. And then also you’ve got the expensive valuation on the ASX as well. It’s trading well above historical averages. So all of that means that the overall index is not offering the same yield as it used to a bit like the banks. So it’s a bit of a quandary where you look on the ASX, you’ve got to pick your spots quite carefully to try to get income.
LaMonica: We’ll certainly go into some of your thoughts around that. But we talked about banks. The other dominant sector in the ASX is the miners. So maybe what’s going on with miners and how does that relate to that overall low earnings growth that you talked about and also lower yields?
Gruber: Some people will look at the miners and they offer high yields. I personally, I’ve been an analyst of miners and I’ve covered them for a long time. I think that investors should never buy miners for dividend yields. You just shouldn’t. Why? Because their earnings go up and down. And if you’re an income investor, you want dependable earnings less volatile. Resource companies are anything but that. And if you look, you’ve done some work on it previously. Mark where BHP earnings and dividends, they go up and down remarkably over a decade. And you don’t really get a reliable income stream. So if I’m an income investor, I think you need to look beyond resource companies for dependable growing yield.
LaMonica: So let’s get into some of the places potentially investors can look. One thing that obviously is very popular is investing in ETFs. There are ETFs specifically designed to generate high yields, different dividend ETFs in Australia and overseas. What do you think about dividend ETFs specifically in Australia?
Gruber: If you think about high yielding dividend ETFs, they’re a bit like buying high yield stocks. Premise is kind of the same. You’re getting a larger starting yield. But the issue is, is whether that yield is going to grow or decline over time. And the problem with these, a lot of the ETFs is that banks and resources are a large part of these ETFs. And particularly the dividend yield on these ETFs. And in fact, they’ve got a very high weighting in both, higher than index weighting in a lot of them, because they have a higher yield than a lot of other stocks. So you’re getting that same issue of, well, the banks aren’t growing their dividends much. The resources are fluctuating a lot. Therefore, these ETFs kind of reflect that, that your yield isn’t very dependable, and it doesn’t necessarily have the growth that you want. And if you look at the past dividend yields, sorry, the dividends that are paid out on these ETFs, they reflect that. They’re not. steadily growing over time, they’re kind of up and down and the growth over five or ten years isn’t what you think it would be. Some of them, you know, haven’t grown over the last five years for instance. So they’re one place that I would look carefully under the broad umbrella when you buy an ETF you’ve got to look at the underlying holdings of it and see how see how they are to determine if that ETF is going to do the job that you think it is, particularly in this case when it comes to income.
LaMonica: So this is obviously really challenging. You know, many income investors are trying to do different things, right? But if you’re trying to generate income, one, you do want growth because you want the purchasing power to increase and obviously we know all that inflation, especially last couple of years, consistency is good, right? If you’re relying on that income, you would like consistent income. Where do we go? You said banks aren’t great, miners aren’t great, dividend ETFs aren’t great. I know you’ve got some ideas. I think people are probably looking forward to those at this point. Where should we go for attractive dividends?
Gruber: Yeah, I should stress that we’re looking stock market-wise rather than other asset classes today. So we’re not talking about bonds or cash, which are a different story and they can certainly be part of the mix right now given that the yields that you get on cash and bonds are a bit high these days and competitive with some of the stuff you get on equities. But in terms of the stock market, I think you can get, I would class it in two ways, is that you want dividend yields now that are reasonable and that can steadily grow. And I think that you want those in defensive kind of sectors. You want, I would highlight ones like the healthcare insurers like Medibank Private, NIB, they offer a decent dividend yield right now. And I’m pretty confident that they will be able to grow those over time. I think the long-term thematics for those insurers is quite attractive. The private healthcare sector in general and insurers are quite an attractive theme given older demographics, increased need for medical care and all that kind of stuff will grow their earnings and dividend streams over time.
And at the moment, they aren’t expensively valued because of the negotiations about the rebates that are happening in that sector right now. But I think that that will work out okay. I can’t see the government interfering too much with regards to that. And I just don’t think it will be a huge negative over the medium or longer term. So those healthcare insurers are quite attractive. Outside of that, I would look towards some of the utilities and energy providers like Origin offers a decent yield as well and has a pretty attractive long-term picture in terms of its long-term growth as well. And in terms of outside of that, I would class you can get dividend yield now, but I would also look at those that can grow earnings and dividends over time. And where would I look with regards to that? Brambles is one defensive kind of yield that you’re getting now. It’s not a huge yield at the moment, but they can grow earnings, I think, high single digits over time given their fantastic moat, global business, and those dividends should compound over time as well.
Things like ResMed also trading below historical multiples. It’s not cheap, but it’s not hugely expensive compared to history. Low dividend yield at the moment, but if they can grow earnings as they have done historically, it’s close to 10%, then you’re going to get a nice growing dividend stream as well. Things like Soul Patts as well is a stock I have long-liked. It’s yield is not huge at the moment, but they have grown dividends over 10, 20, 25 years. They’ve consistently grown their dividend unlike any other company over the last 24 years. They’re almost going to become a so-called dividend aristocrat where they’ve grown dividends over a 25-year period, which is pretty amazing. But they’ve able to grow their earnings and dividends and their dividend stream, I think, has increased about 9% per annum over that 25-year period. If they can get anywhere near that over the next 5-10 years, you’re going to be doing pretty well on the dividend front with Soul Patts as well. They’re very well run, conservatively run conglomerate. There are some ideas for you.
LaMonica: I think the lesson is always listening to you describe. Different shares and different sectors is that, of course, dividends are you are buying a company and the company needs to grow earnings in order to support those dividends. I think that’s a really important lesson for everyone to remember.
Gruber: Yeah, if we back it up, dividends come out of earnings. If a company earns $1, they can pay out a certain percentage of that. As dividends, say, they pay out 50% of that at $0.50 of the $1 and you get the yield from that. So if a company grows earnings from $1 to $2 over 10 years, you should receive a growing dividend stream from that and yield from that. And if you pay a sensible price for that stock, that should work out pretty well over the longer term for income investors.
LaMonica: Yeah, absolutely. And that’s a great place to end this. So thank you very much, James.
Gruber: Thanks, Mark.