Building back better on UK dividends
- Company earnings and confidence have recovered, allowing companies to resume payouts to shareholders
- Dividends are now around 10% shy of their previous highs
- The UK market has the unusual combination of higher dividend growth, higher dividend yield and higher dividend cover.
After an annus horribilis for dividend investors in 2020, 2021 has been far more buoyant. Company earnings have recovered, allowing companies to resume payouts to shareholders, while sectors prevented from paying dividends by the regulators, notably the banks, have been allowed to restart. How does the UK market shape up for dividend investors today?
Thomas Moore, manager of Aberdeen Standard Equity Income Trust, says there has been a broad recovery across the UK market: “We see dividend growth from those companies that continued paying during the pandemic, but also the reinstatement of dividends across a range of sectors Our investable universe is much broader than it has been for 18 months to 2 years. Dividends are now around 10% shy of their previous highs.”
This revival has had several drivers: the UK’s Prudential Regulation Authority has removed the limitations on dividends in the banking and insurance sectors. At the same time, companies that had taken a cautious approach now have greater visibility on earnings and have returned to the market. They have been encouraged by fiscal and monetary support and economic recovery. Finally, many companies have already seen a strong revival in earnings, giving them cash to support dividends and buybacks.
Improving dividend cover
Thomas says that in many cases dividends have come back better. He adds: “It had become a truism to say dividend cover was too low in the UK market. Certainly, some companies were paying unsustainable dividends. It will be interesting to see where the major players settle in terms of their payouts. However, dividend cover is going to improve because earnings are improving dramatically. It is currently 1.9x. This is the sort of level seen a decade ago and up from 1.5x in 2020.”
This gives the UK market the unusual combination of higher dividend growth, higher dividend yield and higher dividend cover. As such, Thomas believes, it is much harder to argue that dividends are unsustainable: “The UK market has plenty of good, cash generative companies, generating high dividends. In low-rate world, this is attractive.”
Charles Luke, manager of Murray Income Trust, is confident that dividends can be maintained – and even grow – from here. He says: “Companies that were going to cut their dividend have done it by now. Coupled with earnings recovery and lower payout ratios this gives us confidence that dividends can be sustained and grown.”
Inflation and higher input costs remain a worry for many companies. However, Charles sees the inflation spike as temporary. He believes bottlenecks will ease and capacity will come back. Nevertheless, he is prioritising companies with pricing power.
On Aberdeen Standard Equity Income Trust, Thomas is heavy in three sectors – financials, resources and consumer stocks. For the consumer sector, he says there have been four quarters where the savings ratio is above 14%, giving an accumulated £200bn in savings. “This money will either get spent or saved. Certainly some people will still be too nervous to spend it, possibly waiting until next year, but is will come back into the domestic economy. Companies such as furniture retailer DFS could be clear beneficiaries, particularly as there has been a supply side shake out in the sector.”
Alternatively, the money may come back into the wealth management sector, once savers realise that they are earning next to nothing on their savings. This explains Thomas’s support for the financial sector. He likes resources because of the impetus created by surging infrastructure spending.
Unloved equity income
Both Charles and Thomas see better times ahead for the long out of favour equity income sector. Moore says: “I feel quite strongly that dividend growth is coming and it’s in a range of sectors. Stocks should re-rate as a result.”
The UK market has struggled to shake off the view that it is dominated by ‘old economy’ sectors such as mining or oil and gas. Thomas resists the label: “If we buy companies that are being disciplined on capital allocation, generating strong returns and growing their earnings and dividends, whether they are in a sector that’s ‘old’ or ‘new’ economy, I don’t mind about the label. The UK market is full of those companies.”
Equally, he points out, if bond yields start to move higher, it may spell trouble for many of the high growth stocks that have done well for a long period of time.
Charles says that on the Murray Income Trust, they aim not to be dependent on any one scenario. “We want dependable, good quality companies and take a patient buy and hold approach. We are diversified in terms of income and capital, with a healthy exposure to mid cap.”
The outlook for equity income stocks has improved markedly over the past 12 months. The UK market has built back better, improving its dividend cover and therefore the breadth of companies available to income investors. Investors should start to take note of this unloved sector.
Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
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- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
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- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.