The COVID-19 pandemic saw company earnings collapse in FY20 as lockdowns took hold and many businesses saw their revenue tumble. 

With this fall in income came a fall in dividends [from Australian shares] - a massive fall of 33% which, given the low level of interest rates, came as a shock to investors seeking income. 

The good news on dividend income is that Australian share dividends have all but regained this loss and are now reaching new highs in terms of dividend yield. 

[Editor’s note: Do not read the following ideas as a recommendation on income investing. Do further research of your own or talk to a licensed financial adviser before acting on themes in this article].

Given recent falls in global sharemarkets, Ausbil believes it could be a good time to be positioning to take advantage of record dividend yields, now pushing 5% for the S&P/ASX 200 index.
 

Dividend opportunities

So, where are the opportunities to earn superior dividend yields in the Australian sharemarket? 

Interestingly, in 2021, Australian resources companies surpassed Australian banks as the largest payers of dividend income by dollars paid, according to Ausbil analysis.

While banks still paid healthy dividends as they recovered from pandemic provisioning, rising inflation and a surging economic rebound saw resources performing strongly. 

The bank and resource sectors paid solid dividends in the last few years, with the added bonus of special dividends and some share buybacks. The three iron-ore companies have now overtaken the four major banks as the biggest payers of dividends in Australia. 
 

Resources have overtaken banks as the biggest dividend payers

While resources have trumped banks as dividend payers, the earnings are concentrated in just a few names, being BHP Group (ASX: BHP), Rio Tinto (ASX: RIO) and Fortescue Metals (ASX: FMG). 

With that, more than 50% of all dividends [from Australian shares] will have come from the four major banks and the three major iron ore companies.

Although global equity markets have experienced significant volatility since the last reporting season in February 2022, with the invasion of Ukraine by Russia and significant increases in inflation from COVID-19 hangovers and the energy shock, the dividend outlook is still solid.

Dividends are based on earnings. As company balance sheets have been repaired, and dividend payout ratios [total dividend paid relative to the company’s income] remain undemanding, this should allow dividends to issue at the same or slightly higher level over the next 12 months as they did last year if earnings also grow, as Ausbil currently forecasts. 

Note that a large part of the reduction in payout ratios is due to the big four banks lowering their payout ratios to more sustainable levels, which we do not expect to see increased.
 

Dividend risks

There are risks, however. Sales volumes can be impacted by both reduced economic demand and problems with supply. Currently supply chains are stretched, and if these issues are not resolved there will be downwards pressure on company earnings, in Ausbil’s opinion 

Moreover, while full employment and the post-pandemic rebound in spending means economic demand is currently very strong, the impact of higher interest rates is expected to reduce this demand. 

While Ausbil does not expect the Australian economy to go into recession, it does pose a downside risk to earnings which would likely pass through to dividends. 

Inflation and supply-side constraints are currently putting pressure on input costs and profit margins. To maintain earnings, companies need to have sufficient pricing power to be able to increase prices to cover these additional costs. 

As a result of these pressures, we expect earnings growth for the next 12 months to vary significantly across sectors. It is important to be invested in sectors that are less exposed to a slowdown in demand and more able to maintain their profit margins. 

Taking an active dividend approach, investors can allocate away from companies impacted as such, and towards those that benefit more in inflationary environments and those that perform strongly across the economic cycle.
 

Dividend trends

In Ausbil’s opinion, sectors well placed to maintain or increase earnings and dividends this financial year include:

• Banks
• Select diversified financials like general insurers
• More defensive sectors including staples retailing, energy, and some quality growth businesses, that are less affected by the business cycle and have strong pricing power.

Overall, Ausbil expects quite low growth in dividends [from the current high level] in FY23. Industrial companies and financial companies with pricing power and inelastic demand are likely to be able to increase their dividends. 

However, resource dividends are likely to fall by 10% or more in FY23 [from elevated levels] based on current commodity forecasts, according to Ausbil analysis. 

Modest growth in dividends is expected from the banks in Ausbil’s view, but this is dependent on interest rate increases not sending the Australian economy into recession.

All this highlights the benefits of a diversified stream of dividends that is not overly dependent on the big resource companies and the big four banks. 
 

Australian dividends are paid across the year, not just at the two reporting seasons

Conclusion

With active approaches to sector allocation, company allocation, and a full year of dividend income events, there are opportunities available for the active income investor. 

An active approach to dividend investing can not only significantly increase the dividends received across the year, it can also reduce the risk from excessive exposure to one or two sectors alone.