Fully franked dividends are great.
Think of them like investment property rental yields or interest on a term deposit – just bigger and better.
Fully franked dividend yields are better than most other forms of passive investment income because they are tax effective. For example, if your company pays a dividend equivalent to 5%, you'll get taxed on the full 5%. However, if the dividend is fully franked, and provided you're eligible to receive the franking credits from the Australian Tax Office, that same dividend yield becomes 7.14%. Basically, when you file your next tax return, you can use the franking (in this case 2.14%) as stored 'credits' which can be deducted against your taxable income.
Fully franked dividends are bigger because, well, they're bigger than most rental yields and term deposits you'll find.
For example, these next five companies have trailing fully franked dividends of 5% or more. 'Trailing' means the dividend yield is computed using last year's dividend payout (dividends/share price = dividend yield.).
Nevertheless, when an ordinary 5% dividend is grossed-up for their franking credits, that's a minimum dividend yield of 7.14%.
- Telstra Corporation Ltd (ASX: TLS) – Telstra's dividend yield is a meaty 5.7% fully franked (8.14% grossed up). What's more, analysts are forecasting its dividend payout to rise almost 10% over the next three years.
- Wesfarmers Ltd (ASX: WES) – the owner of Bunnings Warehouse, Kmart, Coles and more, has a fully franked dividend yield of 5.05% (7.21% grossed up). With its businesses ticking along nicely, Wesfarmers is forecast to grow profits healthily in coming years.
- National Australia Bank Ltd. (ASX: NAB) – NAB shares trade on a dividend yield equivalent to 6.9% (9.6% grossed up). Of the analysts polled by Morningstar, consensus estimates suggest the bank's dividend payout will hold relatively flat in the year ahead.
- WAM Capital Limited (ASX: WAM) – Shares in WAM Capital, a listed investment company (LIC), also trade on a forecast 6.8% fully franked dividend yield.
- Rio Tinto Limited (ASX: RIO) – Australia's largest iron ore miner has a trailing dividend yield of 6.1% fully franked. A plunging share price has resulted in a rising dividend yield.
Foolish takeaway
Dividends are a great way to generate meaningful wealth over the long term. However, you should be very cautious in relying upon trailing fully franked dividend yields as a measure of valuation or worth. For example, in the case of Rio Tinto deteriorating market conditions have prompted many analysts to suggest the company may cut its dividend payout in coming years.
Indeed, just like you would do if you planned to buy an investment property, it's imperative you conduct your due diligence on any investment prior to committing your cold hard cash. In my opinion, of the above five companies only Telstra, Wesfarmers and WAM Capital are investment worthy at today's prices. However, I'd like to see a lower price before buying in.
