Ask Colin

I was thinking about a comment during the weekend seminar regarding the lower dividend yields in the last few years being due to the market pricing in the franking benefits. Does this mean that the average PE's may have risen by a commensurate amount over the same period because the shares are trading at a higher price?

It is actually a complex mix of factors. Dividend imputation is important. Also important is that there has been low inflation, so the risk free rate is lower (bonds) and accordingly, lower yields can be expected on shares, since they all compete for the investment dollar. Finally, there has been some methodology changes made by the ASX. I am unsure how they have affected the dividend yield.

In general terms, though, you are right. Yields have been depressed for several reasons. One is the higher price (the second one above). This will have also inflated the PE ratio. So will the lower inflation rate. Also, the methodology changes, but just how much I do not know.

You should bear in mind that the PE ratio is just the reciprocal of the Earning Yield (PE is P/E, Earnings Yield is E/P as a percentage). Earnings Yields and Dividend yields move together assuming constant payout ratios. The PE ratio moves the opposite way.

By the way, the other possible influence is a change in payout ratio, as mentioned above. Now that capital gains are more favourably treated under the Howard tax reforms, there will be a tendency for payout ratios to fall (more retained earnings), and shareholders to get more capital gain return in place of dividend yield through buybacks. This will mean lower yields and higher PEs.

It is going to be interesting to see where they settle at when the next bear market bottoms out.

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