The value of Retained Dividends and Franking Credits in an LIC portfolio

Flagship Investments Limited (ASX: FSI) is a strong and consistent dividend-paying company that has significant retained earnings and franking reserves to enable it to continue paying its shareholders with a reliable stream of fully franked dividends.

The value of FSI grew strongly over the 6 months to 31 December 2023. As can be seen in Table 1.  FSI shareholders enjoyed over 16% NTA performance during that time. For a growth portfolio in a period of rising interest rates, such a return is a good achievement, a testament to the stock selection skills of the investment manager EC Pohl & Co.

Table 1 source: FSI published monthly NTA and Dividend data

An LIC’s NTA is an after fees and tax-paid number

It is important to understand that FSI’s 16.4% total return over the 6 months was after the running costs of the company have been paid, and after tax has been paid on realised gains in the portfolio. Needless to say when portfolio returns are high, tax paid is not an insignificant amount. 

Franking Credits in an LIC portfolio

A benefit to Listed Investment Company (LIC) investors such as Shareholders in FSI is that an LIC is a wonderful vehicle to pass dividends through to shareholders as well as all tax paid by the company on realised gains via franking attached to those dividends. While the dollar or percentage value of that franking might not appear in published performance tables most shareholders are very aware of its dollar value to them.

Portfolios that invest in profitable stocks can earn additional franking credits because these companies pay fully franked dividends. The additional credits in those dividends accumulate in the LIC accounts in readiness to be passed through to investors. 

LICs can build a franking reserve to pass through to shareholders

When an LIC performs strongly for a continued period it can build up credits in excess of those attached to dividends, and build a “franking reserve”.

A very popular feature of LICs are that they are able to pay dividends to shareholders even when the portfolio has a bad, and even negative performance year. They may not realise any gains (to pay tax and earn franking credits) but they can still utilise their franking reserve to attach franking credits to their dividends. 

Shareholders love it when an LIC passes franking credits on as the credits are able to be offset against the shareholder’s own taxation liabilities.

LICs need to be responsible with the Dividends they pay

In the 2023 FSI Annual Report, it was detailed that a specific objective of the company is to “provide Shareholders with a fully franked dividend, which over time, will grow at a rate in excess of the rate of inflation.”

That becomes possible when a company generates consistent market outperformance. As we can see in Table 2, FSI has certainly done this, with strong outperformance for over 25 years.

Table 2 source: Flagship Investments Limited Shareholders December Quarter Report

While an LIC board may want to pay shareholders as big a dividend as possible, they also must ensure it is not to the detriment of future returns by unnecessarily shrinking the size of the investment portfolio. Logically you would want a strong-performing investment manager to have as big an investment pool as possible. Firstly to keep making more money for shareholders and also to minimise the impact of fixed operating costs of the company.  A responsible dividend policy allows FSI to meet the objective of preserving and enhancing the NTA backing per share by compounding the performance of the manager.

Flagship Investments has paid shareholders a reliable, and growing dividend

Chart 1 shows that FSI pays a reliable stream of fully franked dividends. It also shows it is capable of and prepared to pass strong performance through to shareholders by way of special dividends where appropriate.