Solving the global dividend puzzle

There is also a high risk that trying to plug the income gap will lead to a destruction of capital. 

Many high-yielding companies suffering large drops in earnings and dividends will simply not see a bounce-back to the levels they enjoyed before the pandemic struck

For many such companies we anticipate a permanent impairment of their dividend paying ability.

Worlds apart 

It is important for dividend investors to remember that before COVID-19, high street shops and retail REITs were already under intense pressure from ecommerce. 

Oil companies were already fighting a losing battle against the long-term decline in hydrocarbon consumption. Banks were riding an unusually long wave of near-zero loan losses. Carmakers and airlines, viciously competitive industries for decades, were in most cases making no economic profit. 

Other sectors were replete with companies simply over-distributing capital, whether in buybacks or excessively high dividends.

Once the world defeats COVID-19, these companies are highly unlikely to see their earnings and dividends resume at pre-crisis levels. Established trends are simply being accelerated by the current crisis. There will be no ‘reversion to the mean’. Many companies are facing a permanent dividend decline, not a V-shaped bounce.

Purchasing these troubled companies in the hope they will pay high dividends that plug the gap is therefore a doubly dangerous game. Not only is the dividend uncertain in the near-term, but as investors digest the reality of these companies’ permanently impaired earning power and dividend-paying ability, their capital value post-crisis is unlikely to rebound. This is true risk – the permanent loss of capital. 

What about the less cyclical high-yielding sectors that income investors have traditionally turned to, such as utilities, tobacco, and telecoms companies?

Unfortunately these are mature sectors, fraught with regulatory risk, and with weak long-term growth prospects. They may offer some near-term security of income.

But the investor who piles into these sectors to plug this year’s income hole will face the near-certainty of very dull long-term profit growth. It is not a coincidence that many companies in these ‘low-risk’ sectors, from Vodafone to Centrica, have failed to deliver profit growth over long periods – and in many cases have had to rebase their dividends.

But for all the threats to the income investors' future, the current environment has also created huge opportunities for those with the right mindset.  

The beauty of equity markets is that, as an active investor, you can avoid the companies and business models of yesterday and invest instead in the shares of the future.

That may limit your dividend income in 2020, as these companies have a lower yield than others which are no longer growing.