Share dividend gains set to outpace rising prices

12th October 2011

But longer term, the value of shares is correlated with the cash flowing from them – the often forgotten dividend stream that comes from equity investment.

And looking ahead, the better news, according to the Financial Times citing a leading stockbroker, is that dividends are estimated to rise by 12% in 2012 – or more than twice the anticipated rate of inflation.

The forecast, from brokers Shore Capital is bullish for equity income stocks, and so, by extension, for the equity income unit trust sector. If the firm is correct, this will be the biggest dividend boost for leading shares since 2007. And that could be negative for corporate bonds where many yields are at all time lows.

Shore analyst Alex Stewart compares the yields on dividends with far lower returns on cash or bonds.

He says: "We believe investors holding corporate credit (bonds) at such low yields are basing this valuation on the strength of balance sheets and are implicitly saying ‘this company is not going bust'. So we argue investors are better off buying the equity rather than the bonds, given the former offer much higher yields."

He lists a number of equities where the equity yield, if maintained, is substantially higher than the bond return. Pharmaceuticals group AstraZeneca has an equity yield of 6.11% – 3.6 times the return on its bond. Vodafone equities have a 3.4 times advantage over the bonds while big pharma GlaxoSmithKline is 2.4 times higher.

HSBC, BAE Systems, National Grid, BP, and Prudential all have shares yielding twice their bonds. In Europe, the trend is even clearer – although there is a currency risk for UK investors. Vivendi, the French entertainments and phone group, yields 4.2 times on its equity compared with the bond; Deutsche Post is 4 times, and France Telecom is at a 3.9 ratio.

Dividends from the ten biggest UK-listed stocks – HSBC, Vodafone, BP, GlaxoSmithKline, Royal Dutch Shell, British American Tobacco, Rio Tinto, BG, BHP Billiton, and AstraZeneca, account for almost half of the market's total income.

What's the downside? The global economy does not look good; a euro break-up is a scary possibility; and the UK stockmarket is prone to worldwide shocks. But Stewart says he still expects corporate balance sheets to remain in good shape.

And if he's right? Then dividends grow and that should pull up the share prices of the companies concerned.

"The secret to surviving," says Stewart "is knowing, as every gambler should, what to throw away and what to keep. Do you hold or do you fold?.

If the analysis proves correct, it will be holding equities and folding bonds.

Job Curtis, head of value and income at fund managers Henderson adds:

"I tend to agree with forecasts of good dividend growth. Companies are in reasonably good balance sheet shape – unlike governments or consumers. There is scope for higher dividends as there were a large number of dividend cuts in 2008-09 and many companies, most noticeably among the banks, came off the dividend list. So higher than average growth represents in part a move back to levels last seen in 2007.

"On a more general note, the FTSE All Share Index is yielding 3.5% while the benchmark 10 year gilt offers 2.8%. It is not that often that equities, with their prospects of capital growth, yield more than government stocks."

Curtis is not expecting share values of income producing shares to decline to any great extent – as the yield numbers should provide support.

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