Opinion  

A 400-year-old dividend lesson

Dan Jones

The Tulip mania of the 17th century is a saga with which most readers of this column will be familiar.

The classic example of a market bubble is the ultimate indictment of irrational exuberance, and plays particularly well in the present era of post-crisis nervousness.

Seven years after our own bubble popped, however, I’d suggest it’s not tulips but the story of the firm brought them to Europe – the Dutch East India Company – which is now the more relevant cautionary tale.

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The VOC, as it was known, was the first listed company in the world upon launch in 1602. Its rapacious expansion meant it paid enormous annual dividends for two centuries. Eventually, the eagerness to maintain these payouts was partially responsible for its downfall.

And while the speculative excesses of the tulip era seem outlandish now, the era of unsustainable dividends is with us once again.

In the UK, for example, though several firms have cut payouts, the biggest are clinging on despite yields above the 7 per cent mark. Those most desperate to retain the status quo are paying dividends out of debt.

 

In some cases, external factors like the oil price plunge are partly to blame for these struggles. But the issue is also a structural one. Equity income funds have become more prominent on firms’ shareholder registers, and that’s changed incentives. Large companies are fearful of the reaction from yield-hungry investors were they to reduce the amount they're distributing.

Income managers themselves have become concerned by this dynamic. Neil Woodford said last month that GlaxoSmithKline - a company in which he is a top 10 shareholder - is over-distributing and will only prosper if it cuts payouts.

Bank of America Merrill Lynch’s latest fund manager survey illustrates the increasing concern: the proportion who believe payout ratios are too high is at its greatest level since March 2009.

Worries have grown more acute because earnings have stagnated. US profits fell by 10 per cent last year; European corporates have delivered their worst earnings season since 2008; and, from a bottom-line perspective, UK mega caps are in the doldrums.

The suggestion seems to be, not unreasonably, that companies need to focus on reinvesting in their own businesses, rather than paying out ever-increasing dividends, if they are to regain a sure footing.

Undoubtedly, this would be a painful solution for those who rely on income payments. But UK investors, at least, have had plenty of warning signs.

The high yields now on offer from some stocks suggest the market suspects more pain to come, however much corporates emphasise their resolve.

And ultimately, this may prove a blessing in disguise. Because as the VOC showed, the biggest risk may not be megacaps cutting their dividends – but the opposite.