Our shareholders raised a wide variety of topics at our 2023 Annual General Meeting. Some of the questions put to us related to the performance of the AFIC portfolio, our thoughts on the big banks, how we determine our dividends, and our view on investing in agriculture.
Benchmarking AFIC performance against the ASX 200
The AFIC portfolio delivered a return of 13.9% including franking over the last 12 months compared to the 16.6% return of the ASX 200. Some of the high-quality companies in our portfolio underperformed over the last financial year, including Transurban, ASX, and Mainfreight. Despite these short-term movements, we still consider the prospects for these companies remain strong.
As a long-term investor, there will be times when the AFIC portfolio underperforms the market when assessed on shorter-term timeframes.
The ASX 200 performance over the past two years reflects the strength of the resources sector, particularly smaller resources companies which we don’t have a large weighting in as they typically have inconsistent earnings and dividends driven by commodity cycles. They also often have a poor track record in deploying capital as they look to replace their finite resources.
We believe it’s more important to consider the five-year or 10-year performance figures, and we remain invested in high-quality businesses with good long-term prospects. This investment approach enables us to provide our shareholders with fully franked dividends that are stable and which grow over time.
On the five-year comparison, AFIC’s portfolio has performed in line with the benchmark index when franking is included. On the 10-year comparison, we’re a little bit behind, however given that we must bear costs and pay tax and the Index does not, that’s quite a sound performance. Tax and expenses over the last five years have been a drag on portfolio performance of around about 0.5% per annum, largely reflecting capital gains tax from profitable sales that we've undertaken.
Where AFIC does realise a capital gain, we aim to pass on any LIC credits generated by these capital gains as part of the dividend, thereby providing the opportunity for shareholders to potentially claim a tax deduction. Not all of the franking generated from these realised capital gains is paid out as dividends and is therefore not included in our performance figures.
It also must be remembered that AFIC has low earnings volatility, enabling it to pay attractive, consistent fully franked dividends even during tough times such as the GFC and the COVID pandemic. We have sufficient reserves to support our dividends should there be another downturn ahead.
How AFIC determines the dividends it pays
One of our primary investment goals is to pay dividends that, over time, grow faster than inflation.
In 2023 we paid a total fully franked dividend to shareholders of 25 cents per share, up from 24 cents in 2022.
The main thing we look at when determining the level of dividends to shareholders is the level of earnings, how sustainable we think those earnings are likely to be in the future, and if they are likely to trend upwards.
We don't want to get too far ahead of what we earn because that tends to result in pushing our share price above NTA (net tangible assets) because of the relatively higher dividend yield , which isn’t desirable.
There will be occasions when we may consider it appropriate to pay a special dividend, such as in 2019 when there was a debate about the future of franking, however that is very much a year-to-year consideration.
Do the major banks present any ESG concerns for AFIC?
Broadly, we believe the major banks’ lending standards or risk mitigation has improved quite materially, especially following the inquiries of a few years ago that preceded the Royal Commission into the banks, superannuation, and financial services sector. This is notable even in an intensely competitive market of the last few years.
We believe the major banks fit our aim to invest in quality companies that deliver good returns to investors over the long term and they are well capitalised, well provisioned, and paying attractive dividend yields.
We're not expecting rapid growth in earnings from the big banks, but we believe the level of income that they provide is sustainable and will contribute a meaningful part to our dividends over the long term.
AFIC’s lack of agriculture investment
Agriculture is an important part of the Australian economy, and we aren’t opposed to investing in agriculture companies.
We have followed companies like Nufarm and GrainCorp in recent times, however it is hard to see how companies such as these can generate attractive investment returns over our long-term investment horizon of five-to-10 years.
Agricultural companies are subject to a challenging operating environment with many unknown variables that can impact company performance - even something as simple as whether it rains or not. As such, it's difficult for us to commit to agricultural companies when companies in other sectors have more sustainable opportunities to grow their earnings.
We prefer high-quality companies that generate consistent earnings streams, have strong balance sheets and good management, have great prospects of growing earnings, and which deliver returns at a higher rate than the market over time. Unfortunately, for many agricultural companies achieving that is very challenging. If a company stacks up and we see real value emerging, we may consider the opportunity to invest, but that doesn’t happen often in this sector.