31st July 2014
Investors have long understood that much of the overall return from an equity portfolio arises from dividend income – the more so if it is reinvested. Studies indicate that dividends have generated a significant proportion of the total returns from equities over time. As the chart below shows, the combination of reinvested income with potential capital growth has led to long-term outperformance of higher dividend-paying companies compared to the wider equity market. Significant players such as Apple have only recently started rewarding investors with regular dividend cheques.
But UK fund buyers still tend to concentrate on home-based shares with around twenty stocks accounting for the vast majority of dividend payments. The common assumption that overseas companies are low down on the dividend now looks outdated, Globally, quoted companies paid out a record $1 trillion in dividends last year according to the Henderson Global Dividend Index, a research report that tracks dividend income from the world’s listed companies.
The fund manager says: “With annualised growth in the total dividends paid of 9.4% since the 2009 market lows, we believe there is plenty more to come. Companies increasingly recognise the benefits of attracting investors by being able to demonstrate a strong and growing dividend policy as part of their shareholder return policy. This is well-established in Europe and the US, but the dividend culture is now providing increased opportunities in regions such as Asia-Pacific and selected emerging markets. This broadening universe provides an attractive opportunity-set for equity income investors.”
The reasons for centre on company management’s wanting to increase levels of surplus cash generated, in order for dividends to be sustained. They appreciate that dividends act as a useful indicator of the underlying health of a business.
Henderson adds: “, The capital discipline that a policy of paying dividends imposes on a company’s management team can improve decision making. A sharper focus on cashflow can reduce the risk of business failure and a misrepresentation of earnings in the company accounts. In addition, higher yielding shares by their nature tend to be out of favour, which can offer potential for an upward re-rating in the share price when positive investor sentiment towards the company returns. And as more companies globally pay dividends, the potential to diversify increases. Some markets suffer from dividend concentration (a significant portion of the market’s total dividends coming from a small number of companies or sectors) and as a result equity income strategies focused on single countries risk dividend cuts if any of the big dividend-paying companies or sectors struggle. A global remit also maximises the opportunities at a sector level; for example, many high yielding technology companies can be accessed through investing in the US or Asia, but there are few such opportunities in Europe.”
But investors need to look beyond the headline yield
This is usually based on historic figures. As the yield is calculated by dividing the annual dividend by the share price and multiplying by 100 to reach a percentage figure, a failing company with a falling share price could show a very impressive return. But dividends from the highest-yielding stocks are often unsustainable, with an estimated yield above 5% less likely to be realised in the future. Such companies are often only a step away from cutting their dividend.
The fund manager concludes: “The level of dividends paid by quoted global businesses has been growing and this is forecast to rise further as the health of companies continues to improve. At a stock level it is possible to find companies in markets around the world expected to increase their dividends by around 7-8%.”