Things are once again looking up for dividend investors who focus on the UK.
Computershare’s Q2 UK Dividend Monitor notes that payouts rose by 11.2 per cent on a headline basis in the second quarter of this year, to a record £36.7bn.
The dividend growth is “stronger and more broadly based” than some of the data might suggest, with sectors such as banking and healthcare standing out.
Computershare has more generally forecast a 4 per cent yield from the FTSE 100 over a 12-month period, and even 3.6 per cent from the mid-cap space.
In a world dominated by growth stocks, from Nvidia to Microsoft, the UK’s income prospects do at least offer something for investors. Those who want to generate income in retirement, for example, will find it fairly straightforward to do so from a UK income fund or a basket of domestic shares.
The UK continues to stand out on this front: Asian equity funds can sometimes command similar yields but might seem like more of an unknown for investors, while European funds tend to offer a comparatively low yield and the US is generally seen to offer slim pickings on the income front, even if some stocks and funds defy this trend.
There is still clearly demand for UK income, too: the Investment Association’s UK Equity Income sector held some £36.7bn at the end of June, well short of the £205.4bn in the Global sector but still substantial.
UK companies are more generally loathe to cut or stop their dividends and are often celebrated for maintaining or increasing them over time, as we see with the Association of Investment Companies’ Dividend Heroes list in the investment trust sector.
Dividend disapproval
However, there are serious criticisms of the UK’s strong dividend cover. One is that companies end up paying out unsustainable levels of dividend in a bid to satisfy investors and run the risk of balance sheet problems.
The pandemic did give some big dividend payers such as Shell the opportunity to cut this to what seem like a more sustainable level, but sky-high yields are still common in the market.
AJ Bell’s latest Dividend Dashboard report notes, for example, that Phoenix Group came with a dividend yield of 11.1 per cent at the mid point of this year. However its dividend cover, or the amount of profit it makes divided by the dividend, came to just 0.05 times. Usually a healthy level of dividend cover is seen as 2 times or higher.
Another criticism of the dividend cover has more of an existential bent. The FTSE 100, the segment of the market most readily associated with the dividend culture, has had a reasonably weak showing over the 10 years to August 29, having made a return of 80.5 per cent once dividend payments are accounted for.
That is well behind the 252 per cent sterling return generated by the S&P 500, the 130.5 per cent from Japan’s Topix index and the 115 per cent from the FTSE Europe ex UK index.
Investors have tried to understand the market’s weak performance, and it might be fair to say that some of this relates to the uncertainty hanging over UK-listed shares in the wake of 2016’s Brexit vote, and to the fact that many sectors viewed as being ‘ex-growth’ such as tobacco sit in this market.
But others, including well-known investors such as Nick Train, have argued that UK-listed companies might have done better to use cash to generate organic growth rather than spending so much on dividends over the years.
Could this change? One argument is that, with the likes of UK pension funds owning less of UK-listed companies and overseas investors having a bigger presence, the latter could push businesses to focus less on dividends and more on investing for growth.
US investors, for example, are already prominent on the shareholder registers of popular UK large-cap companies, from Relx to the London Stock Exchange Group. To give another example, Warren Buffett’s Berkshire Hathaway is a major shareholder at Diageo, while US activist Nelson Peltz did build a stake at Unilever.
Some of this, however, may well be wishful thinking. Charles Stanley chief analyst Rob Morgan, for one, argues that the dividend culture is “entrenched”.
“To an extent it is to do with the UK having more mature businesses, and perhaps a little staid in some cases, that are highly cash generative and generally well run but don’t have obvious avenues of expansion beyond organic growth,” he says.
Katen Patel, manager of the JPM UK Equity Income fund, says historically UK companies have struggled when they have sought to prioritise investing for growth over dividends.
He says: "The UK is the highest yielding market globally and companies are rewarded for offering regular and sustainable cash returns to shareholders, therefore company management teams will likely continue to balance investing for growth alongside cash returns to shareholders.
"Historically in the UK market, those companies chasing growth at the expense of profitability have not been rewarded in terms of share price performance."
In fact, he says there were sectors where the emphasis on dividends might increase, such as housebuilding.
Patel says: "The current cyclical downturn in the housing market has led to lower earnings and therefore lower dividends. Post-election, however, we are seeing much more positive commentary from the housebuilders. If this translates into increased activity, the sector could see a strong revival in earnings and dividend payments."
But this should not necessarily be seen as a bad thing. Morgan notes that dividend income has accounted for some 70 per cent of total returns from the UK stock market over the past two decades, compared with just 27 per cent in the US.
However if dividends are predictable, there is no guarantee that the internal investment made by the likes of the US big tech names will come good and generate a strong return.
The UK’s dividend payers could therefore be seen as a sleepy option but one that serves a definite purpose.
david.baxter@ft.com
