Tuesday 12 June 2018 by FIIG Securities financialfreedom Opinion

Don’t count on dividend stocks like Telstra and big banks for your income

Shares are not proxies for bonds. Telstra and the major banks are examples why shares and bonds play very different roles in portfolios – one for growth, the other for income and capital preservation

As published in The Australian on 12 June 2018.

Shareholders have been spoilt by Telstra and big banks in recent years and can be forgiven for thinking the stocks can act like bonds. These shares, often tagged as “bond proxies”, have been consistent and delivered high income with franking credits making them broadly appealing to many investors. But recent history tells us you can’t rely on shares for income or capital preservation and so they should never be thought of as proxies for bonds.

Telstra and ANZ are good examples.

At Telstra, CEO Andy Penn recently cut its dividend by 4.5 cents to 11 cents per share, close to a 30 per cent cut. If you were an employee on a wage, a 30 per cent cut would be devastating, so why take the risk if you or your company relies on that income?

Investing in Telstra or the four major bank shares makes even less sense if you consider growth prospects. In both cases technology and disruptors are challenging the incumbents. The Banking Royal Commission is likely to impose further regulations on the banks that may restrict lending and add to compliance costs.

A dividend cut usually warrants a revaluation of the share price and Telstra has been steadily declining, to $2.77, down around 40 per cent from $4.40 a year ago.

Do investors hold on and hope that the business improves, or decide to sell and invest elsewhere? This is a difficult decision.

In contrast, negative news for bond investors may see the bond price decline but as long as the company survives, investors will be paid interest due and returned the $100 face value at maturity.

Telstra has an Australian dollar bond due to mature in 2020, and it has also been impacted by the challenges facing the company and the recent credit rating downgrade. The bond traded at a clean price of $115.23 at the start of the year and was down to $110.07 recently.

What about the major banks? Are they better bond proxies?

In a similar vein, bank shares (excluding CBA) have traded in a tighter range than Telstra, providing better stability, so I think they are still being seen by many as bond proxies. CBA stands apart with its share price down about 12 per cent since the start of the year. 

ANZ cut dividends in May 2016 from 95 cents a share down to 80 cents a share. Its share price has been more forgiving, at about $26.60.

Investors hope for growth, higher dividends and higher share prices, but the price they pay is uncertainty over capital and the possibility of lower income.

Bank bonds show much lower volatility than shares, provide income certainty and return face value at maturity. Bonds have a different role in a portfolio.

Figuratively speaking, read the warning on the packet, before investing in shares for income. The capital value of your investment could fall, or, dividends could be cut. Typically these two bad news events go hand in hand, as we have seen with Telstra.

Telstra and major bank shares are not bond proxies and can never be. If you want some certainty about your income, stick to deposits and if you want a higher return but still low risk, consider investment grade corporate bonds that will earn 1 to 2 per cent more than deposits throughout the economic cycle.

Invest in shares for growth and bonds for income and capital preservation.