ETF Tuesday

Return to Article

A Hefty Dividend Boosts Australia ETF

Michael Krause

This exchange-traded fund has gained more than 180% since the start of 2001, compared with just a 20% gain for the S&P 500 ETF Spyders(SPY).

Sam Patel, TheStreet.com Rating's manager of mutual fund research, recommended this A-plus-rated fund in recent article as an ideal way to gain exposure to Australia's thriving economy and consolidation in the media industry in particular.

But there's one thing he failed to mention that could make iShares MSCI Australia an even more compelling investment: the country's exceptionally high dividends.

The average dividend yield of the stocks in the fund is 4.1% -- more than twice the 1.9% average yield of the S&P 500 and higher than even the average for the iShares Dow Jones Select Dividend Fund(DVY), which was built for yield-seekers.

Yields are high in Australia not because Australian stocks are cheap per se --although as we'll see later they still sell at a slight P/E-discount to the S&P 500 -- but because the Australian companies in iShares MSCI Australia, on average, pay out a whopping 62% of earnings in the form of dividends, more than twice the rate of companies in the S&P 500.

Although it may seem odd to us now in our P/E-driven market, the payout ratio of the S&P 500 was north of 50% for decades following World War II, and spiked to 60% as recently as 1991.

The reason dividend payouts are so high is that back in the 1980s, the Australian government eliminated the tax on dividends (ending what was effectively a double tax on corporate profits, since companies are taxed on the money they earn). As a result, Australian investors began to demand more dividends -- funny how that works.

Unfortunately, foreign investors, including iShares MSCI Australia shareholders, still get taxed in their home country. Also remember that dividend income received by the fund first goes to pay fund expenses; in the case of iShares MSCI Australia that amounts to 59 basis points.

Kangaroo Jump in iShares MSCI Australia The Australia-centered ETF rises up from Down Under

Source: TheStreet.com Ratings

As a result, the after-fee, after-tax yield that foreign investors can expect to receive is substantially diminished, although the fund still produces a higher yield than either the S&P 500 SPDR or iShares Dow Jones Select Dividend.

The table below shows the net effective yields for the three funds using a hypothetical 15% tax rate.

But high dividends mean slow earnings growth, right? Not necessarily. Between 2001and 2006 (based on earnings estimates for full-year 2006 results), firms in iShares MSCI Australia collectively grew earnings at a compound annual rate of 19.1%, compared with 14.2% for firms in the S&P 500 and 5.5% for firms in the DJ Select Dividend index.

So there was no pattern of high dividend payouts resulting in slow earnings growth. In fact, there is a growing body of academic research debunking the popular notion that high dividends equal slow earnings growth.

Regardless, we're interested in the future, and going forward it appears as if Australian firms still offer good growth at a reasonable price. The companies in iShares MSCI Australia are expected to deliver faster earnings growth than companies in either of the other two indices both this year and next. Despite this, the fund trades at a slightly lower P/E than the S&P 500.

Readers looking for dividends and international diversification -- both of which are generally good ideas -- should take a look at Australia. The Land of Dividends offers not only rich yields but also international diversification, not just for diversification's sake but with stand-alone investment merit, thanks to good earnings growth at a reasonable price.

EPS Growth 2006-07 Est.

Source: TheStreet.com Ratings

Price/Earnings Ratio 2006-07 EPS Est.

Source: TheStreet.com Ratings