In the good old days they were called blue-chip stocks. Investors used to buy these stocks, throw the share certificates in the bottom drawer and forget about them. Well, almost, because twice a year investors would get a very positive reminder when their dividend cheques arrived in the mail.

As the years rolled by, the value of these shares grew. Rights issues, bonus issues and rising share prices all combined to increase investors' wealth. And it ensured the emphasis was on capital growth.

Decisions by the Labor government in the late 1980s changed this traditional approach to sharemarket investment. First, the sale of government-owned icons such as Qantas and the Commonwealth Bank introduced a huge number of new investors to shares. Second, the move by the federal treasurer of the day, Paul Keating, to eliminate double taxing of dividends, which meant giving shareholders a tax break on their dividend income, skewed investment decisions away from capital gains and towards income.

Before this, the payout from shares was less important, particularly from the mid-1970s onwards, when high inflation forced successive governments to run high-interest-rate regimes, ensuring healthy (pre-inflation) returns from fixed-interest deposits. But dividend income has now taken on a life of its own. Brokers and personal investment advisers alike highlight companies' dividend policies, ensuring their clients' investment choices dovetail with their financial needs.

Retirees in particular, who have seen returns from fixed-interest investments dwindle, have turned to high-yielding equities for income. Self-funded retirees, like other investors, were given an added incentive to invest in shares by the latest federal budget, in which the government said investors could claim imputation credits on their dividends as a cash refund instead of being forced to offset the credit against other income.

Dividends are simply the percentage of a company's profits that directors decide to give back to shareholders - their owners. Traditionally, established companies return a higher percentage of earnings to shareholders, although this can vary depending on the corporate and economic outlook. Companies in a growth phase often limit dividend payments so they can reinvest their earnings in further growth.

But that's only a rule of thumb. Rupert Murdoch's News Corp, which boasts a market capitalisation of $A79 billion, has traditionally returned little in the way of dividends to shareholders (the stock is currently yielding 0.23 per cent). In essence, News, which some say has been run as a family business, is always growing and chooses to reinvest its earnings. Investors who buy News shares know their return will come not from dividends but through growth in the share price.

Mining companies, even established ones, are often miserly with dividends. In contrast, banks have been particularly popular for the capital gain and dividends - not service, we hasten to add - they offer. Shareholders who had their introduction to the sharemarket via the Commonwealth Bank float, for example, have enjoyed healthy dividend payments since the first tranche of the bank was floated in 1991. The bank is currently yielding 6.4 per cent.

But healthy dividend payments are not restricted to the blue chips. Mid-market companies are acutely aware that giving shareholders a solid income will help ensure loyalty. Adding to this momentum have been dividend reinvestment plans, prompting analysts to argue that the traditional ratio of between 40 per cent and 60 per cent of earnings being paid out as dividends will rise. This can only be good for shareholders.

The accompanying table of 10 stocks, which comes courtesy of the financial advisory firm The Money Managers, is indicative of this. With one exception, Pacifica, they all offer 100 per cent franking. More importantly, all are "bricks-and-mortar" operations, although as the diversified manufacturer Austrim, and to a lesser extent the media group PMP Communications, demonstrate, this is no guarantee that the dividend stream will continue to flow uninterrupted. (PMP has plunged to around 46 cents, well below its 12-month low of 75 cents.)

What the problems of PMP and Austrim show is that investors have to give high-yielding stocks just as much attention as those shares held primarily for capital gain. Rising share prices and falling yields provide selling opportunities to lock in capital gain and seek other stocks offering higher yields. It just goes to show you always need to be well-informed about your investments.

Austrim's woes, in particular, provide a lesson for investors. In the past four financial years, Austrim continued to increase its dividend. In 1997 investors got eight cents a share, a payout that rose to 11.5 cents in 1998, 15.3 cents in 1999 and 17 cents in the 12 months to June 30, 2000. While this manufacturer was growing fast, it still managed to more than double its dividend in those four years. But 2001 will see a different story. Shaw Stockbroking is predicting a nine-cent payout in the 12 months to June 30, 2001. That prediction could prove optimistic.

The Austrim story is not just a saga of how a company's fortunes can quickly sour. It is also a pertinent reminder to shareholders that companies with solid records of paying healthy dividends can get it wrong. Certainly it is interesting to contrast Austrim's dividend policy with that of Pacifica. Automotive manufacturer Pacifica distributed a higher percentage of earnings to shareholders in the past three years because its operations were more established than Austrim's. For shareholders wanting more security from their investment, Pacifica was the right option.

Companies such as Wattyl, which manufactures and distributes architectural and decorative paints, resins and coatings, and the established oil major Caltex, are similar to Pacifica: well-established companies with solid payout records. Shaw predicts Wattyl will cut its dividend to 14 cents in the financial year to June 30, 2001 (down from 22 cents in 2000), but even at this level it is still yielding 8.2 per cent.

Dividends are typically paid twice a year, with the interim dividend paid after the announcement of the first-half results and the final dividend paid when the full-year results are known. The total dividend is the combined sum of the interim and final dividends, with the yield calculated by dividing the total dividend by the share price and multiplying by 100. The other technicality to understand about dividends is whether they are "ex" or "cum". A stock that is ex-dividend simply means sellers are entitled to the dividend. Cum dividend means buyers get the dividend. Typically, share prices fall after stocks go ex-dividend as the buyer is no longer entitled to the payout.

There is one other thing about dividends that investors should know: when boards announce dividends, they are actually telling the market in advance of an event that will change the price. Experienced traders know this and will respond accordingly.

But even for less-experienced market players, it does provide opportunities. In a bull market, for example, a stock going ex-dividend might provide a window of opportunity to buy at a slightly discounted price. Although investors are not entitled to the dividend, they are likely to quickly recoup the amount as the share price rises again. But you have to move quickly.

Conversely, a stock that is trading cum-dividend can provide investors with selling opportunities in a bear market. In some instances the dividend is the only factor holding the share price up. So while investors have to sacrifice the dividend payment, they are compensated by the fact the stock goes into freefall the day it goes ex-dividend.

Franking explained

Dividend imputation (franking): A tax-accounting device, introduced in 1987, to remove the "double" taxation of company dividends. Previously, dividends paid out of after-tax profits were taxable in the hands of shareholders; the company paid tax on profits and paid dividends to shareholders who, in turn, paid tax on the dividends. With imputation, dividends distributed by companies paying the full Australian company tax rate get a tax credit that can be offset against the shareholders' tax liability on the dividend or, if the shareholder's marginal tax rate is less than the company's tax rate, the excess credit can be offset against tax payable on other dividends, or claimed as a cash refund. -- SOURCE: The Language of Money.

Tale of two stocks

Austrim
Share price, June 20: $0.566
Share price, May 23, 2000: $2.10
ASX Index: Diversified industrial
Market capitalisation: $136 million
Activities: Plant hire - hire of road construction and maintenance plant and car fleets. Consumer - manufacture of clothing fabrics, building, industrial, plastic. Industrial - manufacture of industrial fabric, radiators, seating parts and precision engineering products.
Comment: Interim profit down. Analysts expect full-year profit to more than halve. No final dividend will be paid. Market criticism and falling share price has prompted the company to bring forward a strategic review to late June. Expect asset writedowns, details of restructuring and an update on trading conditions and outlook for 2001-02.

Wattyl
Share price, June 20: $1.47
Share price, May 23, 00: $3.20
ASX Index: Building materials
Market capitalisation: $114 million
Activities: Manufacture and distribution of architectural and decorative paint, resins and coatings in Australia, New Zealand, Asia and the US.
Comment: Further profit downgrade after interim profit was down 69 per cent to $3.6 million. All divisions suffered, especially Australia, with higher raw material prices, GST and industrial action coalescing to hurt the bottom line. Company expects full-year profit to be about break-even. Reasons given include: heavy plant rationalisation costs with benefits to flow later; poor market conditions and inability to pass on price input costs; and correcting past mistakes.

SOURCE: Shaw Stockbroking.

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