Equities set to remain top choice for investors this year

Growth in dividends has been slowing. In fact, last year saw the total amount paid out in dividends fall for the first-time since 2010, falling from £80.6bn to £79.8bn.

A reduced contribution from special dividends was responsible for the lower headline figure.

Over the course of 2013, special dividends reached £2.4bn, almost two-thirds lower than 2012 when there were big payments from Cairn Energy, Vodafone and Old Mutual among others.

Discounting special dividends, £77.4bn was paid out, an increase of just 5.1 per cent, the slowest rise since 2010.

Each quarter since mid-2012 has seen almost unbroken deceleration in underlying growth.

But falling growth is not the same as falling total payouts. It is necessary to consider company profitability to understand the dynamic.

Company profits had a torrid time in 2012 and annual results were still falling as late as early 2013.

Company net profits are still approximately 21 per cent below their 2008 level, so it is no wonder that strong dividend growth was hard to sustain. Equally, decreasing profits didn’t lead to widespread dividend cuts.

Profits are always more volatile than dividends. Companies try to smooth the volatility of profits by not cutting dividends when profits decline or by raising them rapidly when profits bounce upwards.

In spite of weaker profits, firms are in good shape financially. They have built strong balance sheets in the past few years, in reaction to the shock of the credit crunch. They have built their cash reserves to create a financial buffer.

By the summer of 2013, FTSE 100 companies had £166bn in gross cash and equivalents – an increase of £42.2bn since 2008.

Net of their short-term debts, cash balances were up six-fold to £73.9bn. The cash is still piling up.

Now the economy is improving, there is an opportunity for companies to return more to investors via dividends or share buy-backs.

While we do not foresee dividends rocketing, we expect growth to begin to accelerate as the economy moves up through gears.

Companies will be flush enough both to increase investment spending and grow what they pay to their investors.

Dividend performance has varied across the board, for instance income investors saw fastest growth in payouts among industrials in 2013, with general industrials and engineering firms doing best in that group.

The industrials are relatively small, however, contributing just £1 in every £14 of UK dividends.

Oil and gas producers and banks have been the dominant dividend force in the past three years, and with the prospect of Lloyds returning to dividends for the first time since 2008, we can assume this will continue.

The prospect for improved income from the banking sector is good.

2014 will see record payouts thanks to the big Vodafone special, but it is likely to be 2017 before the £100bn mark is breached again, unless companies feel especially generous.

We expect dividend growth on an underlying basis to be 6.3 per cent for the coming year.

With bond yields still low, and cash earning next to nothing, equities will still look like the best place to find income for the coming year.

Justin Cooper is chief executive, shareholder solutions, Capita Asset Services

Dividend payouts: What do they mean?

Justin Cooper, chief executive, shareholder solutions, Capita Asset Services, explains:

“Cutting the dividend is considered to be a major negative signal to investors about a company’s prospects.

“It is usually only if a company accepts that its profits will never be able to catch up again that it will resort to cutting the dividend. Instead finance directors prefer to deliver steady upward progression in the dividend.

“What’s more, dividends are a lagging indicator. They are paid out of recent profits, and so give a rear-view glimpse of corporate health. Slower growth in dividends doesn’t necessarily mean the economic outlook has deteriorated.”