Dividends or Growth? How should Corporate Australia use your money?
During the recent August reporting period Glen Stevens, the Governor of the Reserve Bank of Australia (RBA) caused significant debate around the role of Corporate Australia in stimulating growth within the economy.
Stevens said that the onus now falls on Corporate Australia to take more risk and invest in growth rather than the current trend of growing dividends and capital returns. Once again, dividends were one of the key themes arising from the recent reporting season. Shane Oliver, Chief Economist at AMP Capital points out:
65% of companies have increased their dividends from a year ago (up from around 60% in the last two years)
Dividends grew 7% after 11% growth in 2012, reflecting investor interest in income, strong cash flow growth and corporate confidence in earnings prospects
So do Glen Stevens’ comments over simplify the situation for investors? Firstly, the value of cash globally has been eroded, therefore, more than ever investors are seeking yield wherever they can. Secondly, in a fragile and low growth environment it seems somewhat irresponsible to encourage growth for growth’s sake regardless of the returns management can or can’t see. In the current environment investors continue to reward companies that are returning capital via dividends or buy backs. At the end of the day shareholders are the owners of the business and therefore should have a strong say in how management deploy this capital.
Livewire reached out to three of Australia’s leading to fund managers to find out their views on Glen Stevens’ comments. Their responses are below and raise some interesting points.
A level of political dysfunction not seen since the 1970's
Don Williams, Chief Investment Officer, Platypus Asset Management
Presumably the Governor is keen to see corporate Australia hit the investment switch to make his job in setting interest rates somewhat easier. Given his long career at the RBA he would understand better than most that businesses don’t start investing in growth unless they are confident that there will be an enduring demand recovery as well as having some confidence in their own competitive position in their industry. The reality is that interest rate settings in Australia have been tight relative to the rest of the OECD and we have had, and still have, a level of political dysfunction that we have not seen since the 1970’s. The problem for business is best summarised in the chart below; companies have no pricing power and volume growth is low, hence revenues are stagnant and it is difficult to grow profits.
Stevens’ comments resonate with us
Chris Prunty, Investment Analyst, Ausbil Microcap Fund
He’s right. The Ausbil Microcap Fund is trying to find undervalued growth stories. We want to allocate capital to small businesses that will be much bigger in time so Stevens’ comments resonate with us. You can’t cost cut your way to revenue growth. We also believe that the Australian market’s focus on dividends is a potential source of pain for investors in the future as interest rates normalise and investors go back to looking at growth, balance sheets and incremental returns on capital. With a two to three year view we see some potential pain in the favoured high yield sectors of today. Our preference is for companies that prosper regardless of the macro-economic environment. Playing at the smaller end of the market affords us the luxury of a wide opportunity set of companies with strong reinvestment opportunities that will allow them do well regardless of what economic scenario unfolds.
It's difficult to criticise companies for choosing to return capital
Tim Carleton, Principal and Portfolio Manager, Auscap Asset Management
Australia has no shortage of corporate professionals willing to use funds to invest, innovate, improve and increase their business. We are confident that investment will continue to occur where there are sensible opportunities. At the moment we are in a transition period. For many large domestic facing ASX listed companies the opportunities for investment are perhaps not as obvious now as they have been in the past. On an individual stock basis it’s therefore difficult to criticise companies for choosing to return capital to shareholders, because the investment alternatives are either not apparent or do not make strategic sense from a risk reward perspective. In these circumstances returning capital to investors allows a redistribution of this capital toward companies that have better investment opportunities. This is perhaps how a well functioning capital market should operate. In the short term it may be frustrating that new capital investment is not strong enough to take up the slack from a decline in mining related investment, but over the medium term we believe this will normalise and companies will continue to invest in growth opportunities. If the Government wishes to accelerate this process it could potentially offer incentives for business investment.
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