Europe's dazzling dividends could tempt investors into dangerous waters. Companies are paying out more than normal relative to share prices. While this is usually a signal to buy stocks, the bonanza may not be sustainable.
The dividend yield on the MSCI Europe Index is 3.6 per cent, almost a fifth above the average of the past two decades. This is a good bit above the dividend yield of 2.1 per cent on the MSCI USA Index. And, no doubt it's even more alluring for those whom Citi analysts have dubbed "bond refugees", investors forced into the equity market by pitiful fixed-income yields. More than $13 trillion of global government and corporate debt now yields less than zero.
However, Europe's attractive dividend yields look less enticing when dividends per share are compared with 12-month forward earnings per share. This so-called payout ratio is one measure of the sustainability of payouts. In Europe, it hit 58 per cent in July, the highest in two decades and more than two-fifths above the average for that period, according to Deutsche Bank analysts. Even after stripping out the troubled energy and financial sectors, the European payout ratio is above 50 per cent and close to multi-year highs.
Little wonder, Deutsche's calculations show that total dividends paid by companies in the STOXX Europe 600 Index have risen nine times as fast as total earnings since 2010. The gap may yawn even wider by the end of the year. Analysts' consensus is that European earnings will be 1.6 per cent lower in 2016 than they were a year earlier, according to Thomson Reuters data.
E.ON is a prime example of how focusing on dividend yields alone can lead investors astray. Theoretically, the German utility could be a good bond proxy because it sits in a stable, defensive sector, and has a dividend yield of 6.1 pe cent. In fact, two consecutive years of net losses forced the company in March to prepare investors for lower payouts. This cautionary tale is rather extreme. But, at a time when European share valuations are already pretty pricey, dividend yields' allure is deceptive.
