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Income stocks are often viewed as boring and stodgy. But if you want to outperform the market, you could do far worse than investing in income stocks that distribute a steady and growing stream of fully franked dividends. Maybe it's that the growth stories get the front page – not the stodgy dividend payers. But what's lost in the news is that dividends are a sign of financial strength, of a real business making real profits.

Total Share Return Includes the Dividends

The total shareholder return represents the change in capital value of the shares plus dividends, expressed as a plus or minus percentage of the initial value, usually over a period of 1 year. It is often accumulated over longer periods of 3 or 5 years to show returns for longer holding periods.

The dividend shares figure should also take account of any special one-off dividend payments, as well as regular dividend payouts. As well, in Australia we should include franking credits.

While it is possible that a stock could deliver a negative price performance over a certain period yet still generate a positive total shareholder return should the dividend paid outweigh the stock price fall, in practice this happens only rarely.

Dividend Franking  Credits Boost Share Returns

Australian share investors have something to smile about despite the market volatility, its because of the way they receive their dividends. Depending on the shareholder's personal tax position, they will be paid the dividends on their shares with the tax fully paid already — there's no further tax to pay on them. In some cases their dividends will give them a tax credit and possibly even a tax refund.

The easiest way for an investor to value a franked dividend is to think of the franking credit as part of the income they receive. The investor gets it as a credit from the tax office, but nevertheless it and the cash portion make up pre-tax income. Thus a franked dividend of $0.70 plus $0.30 credit is exactly equal to an unfranked dividend of $1.00, or to interest of $1.00, or any other ordinary income of that amount. (It's exactly equivalent because franking is fully refundable, as described above.)

Dividend imputation is a simple idea, although it becomes a little complicated in practice. In essence, it means that when a shareholder in a company is liable to pay tax on dividend income, he or she is effectively allowed a credit for the tax that the company previously paid on profits from which the dividend was paid.

Dividends Tell the Shares Story

Target reliable dividends that grow steadily over time. Yields greater that 10% may indicate the stock is in trouble and the dividends may soon dry up completely.

Finance theorists use forecast dividends to value shares. One method is to take the current dividend and divide it by the risk free rate less the forecast dividend growth rate. The greater the growth rate the greater the share valuation.Dividend forecasts are what many investors use to assess prospective share investments.

The health of a company can be measured by its ability to generate earnings and growing dividend streams. If dividends are historically reliable and expected to grow consistently, then the share price appreciation will look after itself.

Tags: dividend yield, dividends, franking credits, share dividends