When will the US Federal Reserve (Fed) be done with its rate hikes? Does the spectre of recession push global central banks into a monetary loosening mode soon?
As investors grapple with the future direction of travel of global interest rates, it is sometimes worth reminding ourselves that regardless of where interest rates go, a core investment truth remains: dividends are an important part of equity investing in Asia.
Dividend returns account for the majority of total returns in Asia
It is no secret that stock markets are generally obsessed with share price appreciation. As tales of “multi-baggers” abound in Asia, many investors have been chasing pipe dreams. Yet when one takes a step back and decomposes the region’s equity performances, almost three-quarters of Asia’s long-run equity returns have historically come from dividends (see chart 1).
Consider the experiences of Singapore and Korea. Both countries were known for their rapid economic growth rates in the 1990s, which propelled their economies from agrarian societies in the 1960s into the industrialised nations they are today. Both their stock markets have also delivered almost identical price returns over the last 35 years. And yet this is where the similarities end.
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Abhorring the notion of paying dividends, Korean corporations have largely kept their payout ratios unchanged over the last two decades, even as their Singaporean counterparts consistently raised theirs. This has seen companies from the Lion City deliver a whopping 690% dividend return to their investors over 1988–2022, a figure that easily dwarfs the 345% from the Land of the Morning Calm. Focusing on dividends is key for investors hoping to take a leaf out of the history books. (see chart 2)
Higher dividends = higher earnings growth
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Doubters, however, baulk at this notion. Why bother with boring dividends in a vibrant place like Asia, they ask? After all, only companies which have run out of growth opportunities pay dividends. Aren’t dividend-paying companies just dull, slow-growing companies?
Contrary to this belief, companies that pay high dividends are neither low-growth nor boring. Because corporate managers have better information about their prospects and loathe cutting dividends, they often only pay high dividends if they are confident that their future earnings are robust enough to sustain the payout. This explains why companies that pay high dividends today routinely register the fastest earnings growth tomorrow. (see chart 3)
Taiwanese chip foundry giant Taiwan Semiconductor Manufacturing Co is a prime example. A lynchpin in the global semiconductor space, the company’s earnings per share has increased sixfold over the last decade and a half. Yet, unlike its peers who have used their capital expenditure needs as excuses not to pay their shareholders, the company largely ensured that its dividend payment profile matched its anticipated future profits. As a result, the firm’s annual dividend payouts have largely moved in lockstep with its subsequent five-year earnings growth.
Academics call this phenomenon the “dividend-signalling effect”. As such, for investors seeking to benefit from the Asian economic growth story, focusing on high-payout companies is key. (see chart 4)
Higher dividends = better corporate governance
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Focusing on dividends in a region riddled with corporate governance pitfalls has the added benefit of keeping investors away from potential disasters. Companies reduce the temptation to waste money on value-destroying investments when they return excess cash to shareholders. They also subject themselves to more stringent levels of stakeholder scrutiny when they next tap the markets for funds.
Dividends can only be paid out of real earnings and real cash flows. As a result, Asian companies that pay high dividends are frequently also those with high corporate governance standards. (see chart 5).
Indeed, when the Satyam Computer Services scandal first broke out in 2009, there was much shock and consternation. The company was one of India’s leading IT services providers at that time and a market darling who, at its peak, employed more than 50,000 employees and operated in more than 60 countries.
Markets were therefore left shellshocked when its founder Ramalinga Raju suddenly resigned and confessed to having manipulated its accounts to the tune of INR70 billion over the previous decade.
The debacle caught many investors. Yet, a close inspection of the company’s dividend policy might have revealed something was amiss. After all, its dividend payout looked remarkably paltry for a firm that purported to have compounded its earnings by double-digits over the last decade and sat on US$1 billion worth of cash on its balance sheet. It signalled that either the earnings were not real or that management did not care about sharing its earnings with its minority shareholders. None of that is good for shareholders. Any investor focused on dividends would have done well avoiding this company. (see chart 6).
Dividend stocks appeal to older investors
Notably, our older clients are also increasingly demanding more dividends from their investments. This is not surprising.
Behavioural economists Hersh Shefrin and Richard Thaler have long theorised that individuals do not see all money equally. Instead, they mentally break down their wealth into three separate, non-fungible baskets: current income, current assets and future income. For them, the propensity to spend out of current income is always the greatest, while the temptation to do the same out of future income is the least. And because dividends are viewed as current income, people are happy to spend them. Capital gains, on the other hand, are largely viewed as future income and “jam tomorrow”. The tendency to spend out of them is therefore much lower.
This distinction is important for older customers facing retirement because they increasingly prefer receiving dividends from their stocks to fund their consumption. This should also see them rotating more into stocks paying high dividends. In a rapidly ageing world, the demand for dividends from the growing cohorts of retirees and soon-to-retire will underpin demand for dividend payers, making these stocks attractive investments longer-term.
Given how big a component of long-term equity returns dividends have historically been, and knowing how strong their demand from the ageing population will be, any investor looking for fast-growing companies with strong corporate governance in Asia will do well to pay heed to them.
King Fuei Lee is co-head of Asian equity alternative investments at Schroders
