Maintaining, or indeed starting, an investment in any company involves a range of decisions including how much the company is worth. Depending on the economic backdrop, the price investors are prepared to pay for certain stocks will vary.
The current UK environment of low growth and low inflation has seen a drift towards stocks providing higher levels of income. Set that against other asset classes where returns are low, the attractions of the segment are plain to see. But is now the time to take profits and move on?
I think not, as investors like dividends because they provide a tangible return. Management of the dividend is inherently tied in to capital allocation decisions, cash characteristics and confidence on prospects. Providing the dividend payment is supported by an appropriate capital structure and cover ratios – earnings and cash – it gives strong confirmation of management thoughts on outlook.
A progressive dividend policy is something those at Tilney particularly target.
Dividend growth, averaging 5 per cent over the period, has outpaced earnings since the turn of the century with earnings cover still averaging about 1.5 times – a healthy level. Special dividends have come back in favour with a preference for returning excess cash rather than attempting a diversion to existing group strategy.
This in part has been driven by the impact of profit warnings where companies that disappoint see a far more severe share price reaction than was the case 10 years ago. This feeds directly into the reputation and, therefore, the ability to sell individual investment managers or their firms’ performance record.
Key points
- Dividend growth has outpaced earnings since the turn of the century.
- Investors like to see recognisable household names, offerings and brands.
- The three largest constituents all yield above 5 per cent.
Another factor behind the strength of the equity income segment has been the lack of new issues coming to the market. This, I believe, has reduced portfolio churn with investors preferring safety and certainty over trying to bottom fish established out-of-favour stocks. Corporate activity and consolidation remain features, but the voids need to be filled.
The five-year average dividend yield for the top 100 UK stocks has been 3.7 per cent while the higher yielding pot has been 4.8 per cent. Clearly an average will include both a blend of the constituents' yield along with how the overall index has performed.
Stock and sector rotation has seen many of the larger dividend sectors move in and out of favour in recent years. It is probably fair to say that post credit crunch investors sought the safety of the larger, globally diversified consumer staples.
