There are three reasons to look at a stock’s dividend yield.
The first is to see how much money you’ll make by holding it. The higher the yield, the more money you’ll earn.
The second reason is to use it as a guide for how risky the stock is. The higher the yield, the riskier the stock.
And the third reason is to judge whether it’s an income stock or a growth stock. New companies and those with uneven cash flow tend to be growth stocks. Mature companies or those with consistent cash flow tend to be income stocks.
We mention this because of the hoo-ha surrounding the high dividends you can collect if you own Australian bank stocks.
Just this week, David Potts wrote in the Sydney Morning Herald:
“So instead of putting money in the bank, it might be better to buy a bit of it. You’ll be mates [with the banks] in no time. I can tell you, a shareholder gets paid a lot more than a customer.”
In today’s Money Morning, we’ll explain why high bank dividends are a sign of a declining industry that is desperate for investors rather than an industry that’s trading at a bargain.
You see, the Australian banking sector is now in the last phase that all ex-growth companies go through: the mature or decaying phase.
It’s all part of the business lifecycle.
It’s this lifecycle that usually determines whether a stock is a growth stock or an income stock.
Whether you can expect to see the share price rise spectacularly for big share price gains… Or whether the share price will do nothing, but at least you’ll get a decent income from dividends.
As an investor, if you get on board an investment at the wrong stage of the lifecycle at the wrong time in your life, it can have a big impact on your investments.
Let me explain…
The image below shows how the business lifecycle works. It’s crude and not every business will follow this same pattern. But it’s pretty darn close to how most businesses develop:
Successful businesses start… they have a big growth spurt… they consolidate… have another period of growth… and then they reach maturity.
Of course, at any point during the lifecycle a business can fail. For instance, most start-up companies fail before they achieve any growth. Whereas others go through the full lifecycle before time and innovation finally catches up with them – Eastman Kodak is a great example.
Why this is important for investors is that the more growth a company achieves, the less likely it is to grow as fast in the future. Even a company like Apple [NASDAQ: AAPL] will one day see revenue and profit growth stop. It will become a mature company…
And may even face the same fate as Kodak.
Right now, Australian banks have reached maturity. They’re at the same place where Kodak was 30 years ago. And unless they can reinvent themselves the only way for them is down.
They’ve benefited from years of amazing credit growth, where even a monkey could run a profitable bank. But now the 40-year credit boom has ended, and so has growth.
Bottom line: Australian banks are heading for years of stagnation or decline. If you’re a bank investor it means you need to make an important decision.
At Best it’s Bad News for Australian Bank Stocks
If you invested in banks for growth, you should sell your bank shares now.
If you invested in banks for income, you need to work out if the return you’re getting is enough to make up for the stagnant – and even falling – share price.
Look, this isn’t a bank-bashing exercise. It’s just a function of how markets and the business lifecycle work. You can see how it’s played out on the chart below of the S&P/ASX 200 Financials (ex-Property) Index:
By the way, stagnation is the best outcome. If the end of the 40-year credit boom results in total bank collapse then it’s game over for all bank stocks.
But what if David Potts is right and bank dividends are a hidden gem? That you should buy the high yields before everyone else finds out about them?
That’s just the thing. Australian banks have paid some of the highest blue-chip yields for the past three years.
The reason the yields are high is because investors now see the banks as we do. They are a mature industry heading for stagnation at best, and decay (possibly death) at worst.
No Growth in Banking
In short, when you look at a high dividend yield it’s not simply a case of thinking about all the cash you’ll earn. You also have to think about why the dividend yield is high.
In the case of a small-cap income stock, it could be that investors are yet to find it (although even that’s hard to imagine given how easy it is to scan for yields using even the most basic software), but that’s not something you can say about four of Australia’s biggest companies.
Australian bank stocks pay a high dividend because the years of growth are over.
You may get a good dividend buying them today, but you have to ask yourself: is it really such a good idea to buy shares in a declining industry where the companies’ share prices are likely to fall and dividend growth will be minimal?
We’ll say straight out that it’s just not worth it. If you hold shares of the four big Australian banks, sell them now.
P.S. Buying bank stocks isn’t the only bad idea to avoid. We suggest you check out the latest special report from our old pal, Sound Money. Sound Investments editor Greg Canavan. He’s identified three ways careless investors could lose money this year… and how you can avoid falling into this trap. To see Greg’s special report and take out a no obligation trial subscription, click here…
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