Thinking about the income available from investing in a variety of different asset classes today, UK equities appear extremely attractive.
Of course, relative merits are all well and good, but absolute value is what investors want and it’s therefore encouraging that, compared to the past 25 years, today’s dividends also look attractive, suggesting you are not overpaying to achieve this income.
Having considered the market in general, it’s important to then try and seek out the most attractive income stocks and sectors to ensure you get the best payout and total return for your risk.
There are several things investors should look for including, most obviously, an attractive yield but also a strong balance sheet to reduce risk and the ability to grow the dividends over time – a major reason for choosing equity income over fixed income products.
When it comes to dividend yield, there are several sectors that at first glance look attractive including pharmaceuticals, telecoms, tobaccos and utilities.
All of these are traditional income stalwarts; however, it’s important to look beneath the surface, to ensure they are genuinely attractive.
Unforeseen risk
For investors who are looking for good balance sheets, utilities provide a problem. The sector is full of companies that have significant debts, which appears fine today given how stable these companies usually are, but they inject significant risk if anything unforeseen happens – and the past 10 years have had a lot we didn’t see.
Debt also has the potential to constrain dividend growth as debt providers always come ahead of equity holders and can put the brakes on dividends to ensure they get paid their cash. Dividend growth is something it is worth considering further.
The UK is currently offering some great dividend growth opportunities, with approximately 80 per cent of all 231 dividend announcements made at the end of the recent interim reporting being increases.
However, it is important to identify which of these increases are sustainable and which are not, and this is in part responsible for the caution when looking at some of the elevated payouts currently being offered in the telecoms and travel and leisure sectors.
Rebuilding returns
Something many investors fail to consider when trying to identify dividend growth is that the strongest growth often comes from companies that have had to cut their payout in the past.
The global financial crisis was extremely hard for many businesses, forcing many to cut their dividends significantly. As a consequence, many of these businesses are now seeing strong growth in their payout – or are likely to over the next few years – as they rebuild their returns to shareholders.
