Telstra announced plans to invest in its future yesterday, and the share price plunged more than 10 per cent.
Investors were shocked – shocked! – that a company would decide to hold on to some profit to invest in the development of the company, rather than showering it on shareholders.
In announcing it would cut its dividend by around 30%, Telstra explained (emphasis added):
In adjusting the capital management framework and resetting the dividend policy we have balanced the importance of providing consistent returns to shareholders with the long term sustainability of returns and strategic direction of the company.
We realise this is a material reduction from the historic level of our dividend reflecting the lower payout ratio. We do not underestimate the impact of this on our shareholders. It is for this reason we are providing advance notice of this change and why the Board has maintained a 31 cents per share dividend this year.
Owning shares, over the long-term, is a fairly reliable way to accumulate wealth through price growth.
In Australia, it is also a very tax-effective way to earn extra income because of the franking credits system which means dividends aren’t counted in your personal income.
And companies do love to talk about their dividend. Take CBA, which dedicated considerable space to celebrating its stable dividends to shareholders in its recent annual results. “CBA dividends are paid to more than 800,000 shareholders and to millions more through their super funds,” it noted.
The prospect of a dividend provides support for the share prices of companies offering attractive dividends. In some cases, such as Telstra – a company widely held by retail investors – it has the potential to inflate the share price because of demand from investors seeking income.
Today’s price action suggests that premium, at least for Telstra, is of the order of 10%.
The company has warned this might be coming. In a recent TV interview, Telstra chairman John Mullen said as much.
— Sky News Business (@SkyBusiness) July 18, 2017
“Boards review dividend policies all the time and we live in an extremely changeable world at the moment,” Mullen said on Sky News Business last month.
“It’s fascinating that the potential competitors of the future, not the traditional Optus or Vodafone but more likely the Amazons of the world, don’t pay a dividend.”
He went on to explain that the world’s most dominant companies “reinvest their ever-growing cash flow into cheaper and better products to gain market share”, said there was a “growing divide between some of the older established companies and the newer companies – not just because of technology but also because of the new investor models.”
Mullen then helpfully pointed out that if Telstra hadn’t paid dividends for 10 years then it would have “a $50 billion war chest to take on the new competitors”.
There’s an obvious comparison here for how it can be done differently. Amazon.
It pays no dividend and barely turns a profit on its $US136 billion ($A171 billion) in revenue.
Another way of looking at that is Amazon spent $171 billion on growing its business over the past year.
(For comparison, Telstra’s full-year revenue in 2016 was $26 billion, or for a retail example, Woolworths turned over $58 billion.)
Amazon’s share price has hit record highs as revenue has soared. This is what Mullen is referring to when he talks about “new investor models”.
This table shows Amazon’s quarterly revenue growing from around $US23 billion in to $US37 billion in the space of just three years.
The monster revenue growth and the N/A entries under dividends are not unconnected. More on that later.
The enthusiasm among some investors to own stocks for the dividend has long been a talking point in professional financial markets circles. Of course, it is a great thing to own a stock and get paid for doing so, but the encouragement from the tax system through franking and the investor culture of seeking dividend stocks may be not just warping the market, but also restraining companies from growing their businesses (and the value of their shares) more aggressively.
A culture of dividend hunger among investors also incentivises boards and CEOs to redestribute profits rather forcing them to spend time in forensic consideration of the smartest investments for the company’s long-term prospects.
Richard Coppleson, the former Goldman Sachs equity strategist now at Bell Potter, let rip a spectacular rant earlier this month on the problems with investor psychology in Australia around dividends on stocks like Telstra.
In the August 8 edition of his celebrated daily “Coppo Report”, Coppleson revealed he had had barneys with clients about their insistence on holding Telstra for the income. Here’s what he said:
Now will those (blind) Telstra bulls (at any price) finally listen – I’ve had massive fights with (mainly those who are “big” on income) that the stock is going lower & dividend could be a risk.
They argue that everyone’s on the phone – their kids use it, the NBN, and “Hey Coppo – you just don’t get it you nor all those stupid instos (sorry guys you were also included) – Ok when this took place the stock was at $5.00 & they “pay a 31c dividend – now that puts them of a big fat dividend yield of 6.2%”.
They go on.. “Coppo you just don’t get it do you – it’s on a 6.2% FULLY FRANKED dividend yield – so if you ”gross it up” then it’s on a dividend Yield of 8.8% that’s vs RBA Cash Rate of 1.5% – I love that type of investment” (and guess what this guy also thought the RBA was going to cut). Ok he “loved” Telstra back then at $5.00 & yield of 6.2% ff (he was “piling them into his Super Fund as it was a real “no brainer”).
well the “Dividend Yield” on Telstra today has “ballooned” out to 7.5% ff, or grossed up 10.80% BUT the share price has dropped from $5.00 to $4.09 a drop of -91c or a capital loss of -18%.
So the lesson is that investors want “income” and that is only going to increase over time.
BUT chasing a stock for its “yield” only (and the bigger the yield the more you should worry) has never been a great strategy.
BUT having said all that Telstra will find massive buying support anytime it gets to $4.00 as yield hungry investors look for income. The other way to look at Telstra here at $4.09 is that say they cut the dividend from 31c to 26c a huge 16% drop – at 26c the stock would be on a dividend yield of 6.3% fully franked or 9.1% grossed up.
So I’d say we have got Telstra stuck in a solid trading band of $4.00 BUY… to $4.50 / $4.75 SELL….
(As it happens, after its initial plunge, Telstra shares have climbed off the mat and a short time ago were trading at $3.99, down 8% and just 1c lower than where Coppleson said it would find buyers.)
Anyway, amongst other points Coppleson argues that buying a stock for “income” has “never been a great strategy”.
This is simple. You may get a tax effective income stream but if the share price declines over time you could lose big chunks of capital. So the guy in Coppleson’s example loading up his super fund with Telstra shares lost 20% of his capital. Hopefully, he didn’t buy too much.
But he surely will not have been alone.
Perhaps this will prompt some share owners – retail investors in particular – to reconsider why they really hold various stocks.
And perhaps Telstra’s decision to start holding on to some profit to plan for its future might get other companies thinking about it too, and bring some focus to boards — and from their shareholders — in terms of what is really involved in building successful companies with a sustainable, long-term plan.