How to seize the income opportunity

This article is part of
Guide to UK equities after the pandemic

How to seize the income opportunity

The dividend yield figure published by companies is comprised of two numbers: the share price and the percentage of cash being distributed.

Rob James, fund manager at Premier Miton Group, says an unusually high dividend yield number is a sign “one of the two numbers is wrong”. 

This means either the company does not have the cash to pay the dividend at the level expected, or, if the company really is generating the correct level of cash, then the shares are cheap. The share price rises as the wider market realises this.

Article continues after advert

A feature of the UK equity market coming into the pandemic was the significant number of stocks trading on the wrong yields, and not able to pay the dividends claimed by the data, according to Alan Dobbie, UK equity income fund manager at Rathbones.

Companies such as Shell did not generate enough cash for the dividend they paid pre-pandemic, he says, and used a combination of debt and scrip dividends (that is, paying the amount via more shares in the company rather than cash) to make up the shortfall. 

Dobbie says the “accusation” surrounding many UK stocks for years has been that dividends would eventually have to be cut as they were unsustainable, but the effect of the pandemic has been to force the hands of management, who have announced dividend cuts.

He says the new levels are generally more sustainable and the market has taken the pain.

Dobbie adds that while the FTSE currently yields 2.8 per cent, he expects dividend growth to be about 25 per cent this year. Crucially, the sources of income are far more diverse than has been the case in the past, when an over-reliance on a small number of shares produced a negative impact on sentiment towards the domestic market.  

He says he expects dividends in most parts of the market to return to previous levels soon, “except for oil, which we don’t think will get back to previous levels”. 

Dobbie says many of the consumer staple stocks such as Unilever were able to continue to pay dividends in 2020, despite the pandemic, as were some insurance companies, and these act as a base for the year ahead, while he said banks had the cash to pay dividends last year but were forbidden from doing so by the regulators.

However, he says he expects that at least two of the banks, Lloyds and NatWest, will pay dividends in the year ahead.

Alan Custis, UK equity manager at Lazard, says the challenge for UK income investors is that many of the traditionally strong income-paying sectors, such as banks, are faced with structural challenges to their business models in future, but says in the shorter term there “should be more money for dividends”. He adds that “it is hard to justify owning bank shares without having the dividends”.