Focus on paying high dividends leaves investors worse for wear

The poor performance of the New Zealand sharemarket - and economy - could be the result of companies paying profits in dividends instead of investing in growth. In the first of a three-part series, business editor JIM EAGLES investigates.

Why has the New Zealand sharemarket performed so badly in the past few years?

Is it, as is sometimes claimed, because New Zealanders lack the skills to run big companies? Is it because our economy is lagging behind the rest of the world?

Or is a major factor the way many New Zealand companies pay out nearly all their profits in dividends instead of investing in growth?

A quick look at international sharemarket statistics suggests that New Zealand is the odd country out when it comes to both sharemarket growth and dividend policy.

By any standards, the New Zealand sharemarket has been disappointing.

An analysis by investment consultants Frank Russell Company shows that over the past five years, the NZSE 40 index has fallen more than 3 per cent.

By contrast, anyone investing New Zealand dollars elsewhere in the past five years would have seen the ASX All Ords ahead by 8 per cent, the MSCI UK up by 14 per cent, the S&P 500 up 21 per cent and the MSCI World Index up by 20 per cent - despite last year's fall.

Some of that movement was due to the decline in the New Zealand dollar, but even in local currency terms the Australian and British indices were up 9 per cent, the S&P by 8.5 per cent and World by nearly 8 per cent over that period.

It was not always like that. As recently as 1991-96, the NZSE 40 outperformed several of the major market indices.

Its 8 per cent rise over the five-year period was about 1 per cent better than either the ASX or the MSCI World, and almost on a par with Britain, although still short of the 14 per cent increase in the S&P.

So why has the NZSE gone from hero to zero (or, in fact, less than zero)?

What has changed?

It has not gone unnoticed that the NZSE's fall from grace has coincided with a sharp divergence between dividend policy in New Zealand and that in most other countries.

Since 1975, the proportion of United States companies paying dividends has fallen from 75 per cent to 22 per cent. A similar movement has occurred in most other developed countries.

At present, only 24 per cent of Australian companies and 32 per cent of British companies pay dividends.

The proportion of New Zealand companies paying a dividend rose from around half to an overwhelming 85 per cent.

And, the share of company profit paid out as a dividend in New Zealand also increased and now stands at 82 per cent.

That, too, is in sharp contrast to the pattern elsewhere.

United States companies now pay out only 28 per cent of profit.

In Britain, the figure is 47 per cent and Australia is a bit closer to New Zealand with a 69 per cent average payout.

A further indication of the divergent trend is in the Financial Times's world stock markets review, at October 31.

New Zealand's dividend yield (at 6.2 per cent), was double Australia's (3.1), 2 1/2 times Britain's (2.4) and more than four times the United States yield (1.25 per cent).

It was the highest in the OECD and across all world markets was only bettered by Argentina (9 per cent), Peru (10.2), Russia (10.5) and the Czech Republic (6.8).

Unfortunately for New Zealand investors, the high level of dividends has not balanced out the slide in share prices.

Even when dividends and capital gains are combined, returns from the New Zealand sharemarket have still lagged well behind.

Over the past five years, gross returns here have amounted to just 4 per cent, compared with 9 per cent in Australia and Britain, and 11 per cent in the US (in local currency).

There are many factors involved when it comes to the use of profits.

The variation between taxation systems in different countries often has considerable influence.

Many companies prefer to return money to shareholders by buying back shares - in the US, especially, it is considered more tax-efficient than paying dividends - although that is not common in New Zealand.

Overseas companies are more likely to issue share options to senior executives which tends to make going for growth look attractive for managers.

Some of the foreign owners of New Zealand companies have shown a desire to export most, if not all, of their profits.

But none of that alters the fact that the New Zealand focus on dividends does seem to have left investors worse off.

All of that raises two important questions.

First, why is New Zealand's dividend policy out of step with the rest of the world?

Second, what effect does the high-dividend policy have on the wider economy?

* Part two, tomorrow, discovers that for managers in other countries to distribute the bulk of profits in dividends is an admission of failure, an acknowledgment that they have nothing better to do with the money. Why don't New Zealand managers feel the same way?