Equity Income  

Prudent dividend cutters are best bets for equity income

Prudent dividend cutters are best bets for equity income

The first half of 2020 has been brutal for equity income investors, who have suffered sharp share price falls and widespread dividend cuts in the wake of the Covid-19 crisis.

The scale of these cuts, suspensions and cancellations has been huge, and it will continue to be a challenging environment for income investors for the rest of the year and into 2021.

But this does not mean investors looking for income should disregard the stock market. Indeed, the overall picture is much more mixed, despite the ongoing sense of gloom. 

While an estimated 176 UK-listed companies have cancelled payments and a further 30 have cut their dividends, some companies have increased their dividends and others have recently reversed decisions to suspend or cancel their payments.

More than ever, investors should be selective about in which companies they invest for income.

Now the dust is beginning to settle, investors need to be more circumspect, block out some of the background noise that can cloud their judgement, and search for investment opportunities with fresh eyes.  

Key points

  • Equity income has been tough for UK investors this year.
  • Many companies have been punished for acting prudently.
  • There are stocks developing innovative dividend policies.

Somewhat counterintuitively, some of the most attractive stocks, with the best long-term prospects, can be found among the global leading businesses that cut dividends in the second quarter of this year.

Under normal circumstances, a dividend cut is a signal that a company is uncompetitive in its end market, is cash-poor and has weak long-term prospects.

However, we are living in extraordinary times, and many companies have been punished for simply acting in a prudent manner, especially given the seismic and sudden impact of the crisis.

Maintaining operations

Some otherwise sound businesses cut dividends so they could shore up balance sheets and maintain investment in their operations. Such companies can be found in a range of industries, from media to consumer skincare and machinery.

Standout examples from each of these sectors include Disney, Estée Lauder and Rational – three very different companies that have been directly affected by Covid-19 and the subsequent changes to behaviours within society. 

All three cut their dividends, and their share prices took a hit as a consequence. Nonetheless, all three have the potential to provide strong returns over the long term, in our view, and the sell-off in their stocks presents an opportunity to buy into this potential at a lower price.   

Reeling from the closure of its theme parks in March, Disney cut its dividend in May, scrapping its semi-annual dividend. In line with a deteriorating outlook, the Disney stock price returned to levels not seen since 2014.

However, the future economic prospects for the company are not its theme parks, but its direct-to-consumer operations like Disney+, Hulu and ESPN+.

With Disney+ hitting 60m subscribers within the first year (compared with Netflix who took eight years to reach this number), the company is succeeding in its attempt to diversify away from its more traditional lines of income.

Not to mention that Disney has a fortress balance sheet with $27bn (£20.8bn) of cash on hand, and therefore, we expect the company to return to dividend growth next year and provide investors with a steady stream of income for years to come.