National Australia Bank Ltd. (ASX: NAB) shares and Telstra Corporation Ltd (ASX: TLS) shares pay fantastic fully franked dividends.
What are Franked Dividends?
'Franking Credits' are a tax-effective 'credit' that can be paid by Australian companies to Australian residents, superannuation funds and trusts. The Australian Tax Office (ATO) stores a credit against your name for the tax already paid by the company. When tax time rolls around, the ATO credits your account with the tax already paid.
There are a few rules to understand, and you must own the dividend-paying shares for at least 45 days. But ultimately, franking credits can boost your after-tax dividend income.
NAB
National Australia Bank shares pay fully franked dividends, meaning each dividend comes with the maximum tax credit. Impressively, shares in Australia's fourth-largest bank are tipped to pay a dividend of 5.8% fully franked. In after-tax dollars, that's a gross dividend yield of 8.3% for eligible shareholders. Try getting that at…errr…the bank?
Telstra
Telstra shares also pay a large fully franked dividend. Currently, analysts expect the $55 billion telecommunications company will pay a dividend equivalent to a yield of 6.7% fully franked, or 9.6% in after-tax dollars for eligible shareholders.
NAB or Telstra?
I must emphasise the fact that dividends are not guaranteed. A company's board of directors can choose to withhold a dividend whenever they see fit. However, if the company is generating sustainable profits, dividends can provide a consistent – and potentially tax effective – income.
One way to build an understanding of the sustainability of dividend payments going forward is to compare profits to dividends. At current levels, Telstra is forecast to pay around 95% of its profits as dividends. That means, just 5% of profits could be put back into the business to fund growth projects. NAB pays out 82% of its profits as dividends.
You may think that because NAB has the lower payout ratio that its dividends are more sustainable. However, we also need to consider the business model and whether or not we can rely on the same level of profits going forward.
In my opinion, Telstra's business generates significant cash flows because its infrastructure assets (e.g. its mobile network) has already been built and its customers have shown that they are willing to pay a premium for its products. Imagine for a moment that the economy took a turn for the worst, would NAB's or Telstra's profits be worst affected?
In my opinion, Telstra, although it pays more of its profits out to shareholders as dividends, should provide a more consistent dividend going forward. It may not always be at the same level (currently Telstra pays a dividend of 31 cents per share), but its business lends itself to paying at least some profits to shareholders even in tough market conditions.
Foolish Takeaway
If you are investing for dividends, it's important to understand the business, how it generates profits, the sustainability of those profits and how the board intends to return capital to shareholders.
Also, I said Telstra's dividend is probably more sustainable than NAB's. However, the best share dividend portfolios include more than just one share. Around 20 shares would be a good target, in my opinion.
