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Dividend and conquer: How bright is the outlook for UK dividends?

Dividend and conquer: How bright is the outlook for UK dividends?
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The UK market has long been the darling of equity income investors, not least because it has boasted a dividend yield of more than 4 per cent for most of the past decade, but the UK was also the worst affected major equity market when it came to pandemic-driven dividend cuts.

By February 2021, annual payouts from the FTSE All Share Index had fallen to just 57 per cent of their January 2020 levels compared to lows of 89 per cent for the rest of the world.

But despite the cataclysmic fall in dividends through 2020, the UK remained the highest yielding major equity market and enjoyed a rapid rebound in 2021, with dividends in the third quarter of 2021 nearly double those paid out in the same period in 2020.

Some of this was driven by the resumption of bank dividends as the regulator-imposed ban was softened at the end of 2020 and entirely lifted over the summer. But more important was a surge in special dividends from the mining sector, which enjoyed bumper profits as commodity prices soared.

The top payer over the third quarter, mining company Rio Tinto, increased its overall annual payout by 41 per cent compared to the start of 2020 and by 233 per cent compared to early 2021’s lows.

This has left the stock with a historic yield of nearly 13 per cent, but it will not be sustained. Iron ore is the largest segment of Rio’s business, responsible for more than 80 per cent of the miner’s earnings in the first half of 2021, but prices have halved since June and analysts’ estimates for dividends over the coming year are being cut too.

Looking ahead

The picture looks rosier in other sectors though. House-builders, industrial chemicals, and IT have more than doubled their payouts in the third quarter of 2021 versus last year, but the strongest growth has been in the retail sector. 

It experienced some of the harshest cuts during the pandemic so admittedly the bounce back is from a low starting point, but most companies in the sector have resumed dividend payments and their recovery is expected to continue, especially now the economic hit from Omicron is expected to be less severe than first thought.

So, while the mining stocks that have led the dividend recovery so far are unlikely to continue such generous payouts, we expect other industries to pick up the slack. As long as oil and gas prices remain elevated, the energy sector will offer support too. Taken as a whole this means the UK market should deliver a similar amount of dividends in 2022 as in 2021, but with less sector concentration, which should make the dividend recovery more durable.

Globally, the UK market still offers the most attractive dividend yield on a forward-looking basis. This is partly driven by the discount that UK shares trade at compared to their global peers. So not only does the UK present an attractive opportunity for income investors but there is scope for superior price returns as the economy adjusts to its post-Brexit state and international investors’ confidence returns.