Dividends are an important ballast for a portfolio in difficult market conditions, but some sectors are vulnerable to cuts and dividend volatility.
– Dividends form the bulk of an investor’s overall return
– Regular and reliable dividend payments are often a sign of a good company
– Investors need to be sure that dividends are resilient
In uncertain times, dividends can be a vital source of reassurance. Even if a company’s share price is bouncing about, at least investors are getting a little bit back year in, year out. However, not all dividends are created equal.
Historically, dividends have formed the bulk of an investor’s overall return. From time to time, the market will become very excited about rising share prices – particularly in the technology sector – but it is dividends that make the difference over the long-term. Without the impact of compounding dividends, the FTSE 100 would have been flat since 2018. As it is, investors have doubled their money.
In general, the dividend picture for UK companies is buoyant. Payouts rose 4.1% in the three months to September. At £32.3bn, they broke all previous records for the third quarter (1.). This strength was driven by a particularly strong showing from financial and mining companies, plus a small boost from a weakening pound. Oil giant BP also grew its dividend for the first time in four years.
While this strength is to be welcomed, the picture was not universally rosy. It is good to see the mining sector returning to form, but it has spent a long time in the doldrums. At the same time, retailers stood out as a weak spot. As profits decline, so are dividend payouts. While most have managed to hold their dividends flat, Next’s dividend was significantly lower this year with the group not making its usual special dividend this year. Debenhams’ dividend, already unimpressive, was halved.
This shows the importance of looking beyond the headline rate for dividends. Beneath the surface there will be sectors struggling and those growing their dividends. This may depend on a number of factors: a stronger economy, for example, will see sectors such as banks and mining doing well. At the same time, sectors may be subject to disruption from new incumbents, as has been true on the high street. This will affect their earnings and therefore their payouts to shareholders. For those who rely on the income from their investments, this unpredictability is unhelpful.
How can investors introduce more predictability into the payouts they receive? We believe that dividend and company analysis are intertwined. Shareholder distributions are the output of a business model. Good companies pay dividends and paying dividends imposes a strong discipline on companies not to do reckless things with investor capital.
On the Dunedin Income & Growth Investment trust, we identify a number of factors that, when combined, identify a company as higher quality and therefore more likely to sustain and grow their dividend over time. A company may have a strong competitive position, low debt and good cash flow. It should have a strong management team that put shareholders interests first. It should be in an industry that is seeing structural growth, rather than long-term decline.
Increasingly, we are also paying close attention to the attitude of the management team towards environmental, social and governance criteria. We believe this is vitally important in ensuring the long-term
sustainability of a business, and therefore of its dividend payouts to shareholders. We are owners rather than investors and will meaningfully engage with companies to bring about an improvement in these areas. It is easy to believe that this stability is unlikely to be found in UK companies today because of the uncertainty on Brexit. Certainly, many international asset allocators have concluded that it is too difficult to invest in the UK today. However, to our mind, UK companies have certain unique characteristics that mean they are still a good place to hunt for dividend income.
The first line of defence for UK companies is their intellectual property. For many companies in the UK, this is highly developed and will be protected by internationally recognised patents and strong brands. At the same time, many have experience of operating abroad. As an island nation, UK companies have been forced to be international from the outset. There is skilled human capital in the UK, a function of a developed education system and specialist knowledge. Companies generally display strong corporate governance and operate within boundaries that protect the rights of shareholders. The UK also has a robust legal framework, where ownership of physical and intellectual property is respected and maintained as a result of a sophisticated and independent legal system. These advantages will endure long beyond the current disruption around Brexit.
UK companies have a lengthy and impressive track record of paying dividends. Today, payouts ratios – the level of distribution relative to earnings – look far more robust than they did a year ago. At the same time, the dividend yield for UK companies is notably higher than for other areas. Investors should not be deterred by problems surrounding Brexit, the UK is still a good place to find reliable dividends as long as you look with care.
1. Capita Asset Services, November 2018
Important information
Aberdeen Standard Investments is a brand of the investment businesses of Aberdeen Asset Management and Standard Life Investments.
Risk factors you should consider prior to investing:
• The value of investments and the income from them can fall and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
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• Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
