Unlike during 1990’s, when rise in share price is much more than the interim dividend payouts by the companies, dividends are one of the most important factors to consider these days for any investor who looks for rather stable & less risky returns than going for aggressive investment strategies, while making their investment decisions. These dividends are the only income stream generated from the equity, representing its asset value, & form the lion’s of share of 60% of the total returns. This can be proved by the marginal increase in LSE share prices over the last decade, with the FTSE All share Index climbing back to level of August 1997, compared to the dividend income from them being 19% if reinvested & can say investors almost tripled their money in the last 10 years before the recession. So, it does make sense for the investors to consider dividends seriously while making their investment decisions. The recent recession and the credit crunch have affected all walks of the economy with the more profound effect on the stock markets. The UK equity market has had a tough time during the last couple of years. Many of the high yielding blue-chip companies have proved to be cyclicals & as market experts say, the best companies in last couple of years were generally the ones that suffered huge losses & biggest share price falls. During the previous recessions, while the common stock market share values were going down, newer forms of investment options for the average investor were evolved in the form of mutual funds, Gold, ETFs, Commodities etc., These MFs in theory were supposed to perform well or even better than the stock market fluctuations due to its inherent advantages of enormous capital and the professional and knowledgeable fund managers. This myth of the performance of the stock & mutual fund market also has been crumbled with the present recession. Most of United Kingdom’s equity funds focussing on regular income to its shareholders through dividends are forcing a cut back on their income as most of them depended on the banking sector. With the near collapse of Royal Bank of Scotland, Halifax Bank of Scotland and the poor performance of Lloyds Bank, NatWest Bank, the banking sector has witnessed either a scraping of the dividends or slashing (Kelleher, 2009). Some of the investors have already started moving away from even the better considered income mutual funds to other type of investments, but retirees who need regular income for their subsistence face the burnt of the recession and the loss of income. Dividends are the payments issued by companies to its shareholders as a part of their after-tax profits on a timely basis. This is nothing but the partial disbursements of the profits of the company to its share holders. In UK, these dividends are paid twice a year. They represent real cash unlike the stated ‘profits’, less volatile, and not subject to changing accounting policies so not subject to back adjustments & revisions. Companies try to maintain a sustainable dividend payout level as a good share is one where the dividend has increased consistently. However, a good high dividend stock not only maintains consistency in payment of high dividends but also shows future growth in dividend payouts without constraining the future growth in the share price. In addition, the higher the dividend cover the better, as the company is more likely to maintain the dividend in future years even if profits drop. High yielding stocks paying dividends always outperform the lower yielding non-payers. Ex: FTSE 350 Higher yielding index rose 40% against 23% fall in lower yielding index over the last decade. The above chart plots the monthly close for the FTSE 100 Stock Index. However, the dividend payouts of the companies depend on their profits and require them to have strong balance sheets & cash generation sources. According to Jane Zhou, Markit’s U.S. dividends manager, many considerations go into the decision-making of dividend payouts starting with an economic forecast followed by the general market conditions, company financial performance, with further drilling down to the proposed development options & new revenue sources available to the company. The mutual funds, which invest in such dividend paying stocks, will pay out these dividends in the form of regular incomes to its shareholders.
During the recession, many companies especially banks and financial institutions have seen their profits plunge & share prices fall steeply and needed government support by way of cash injunction to run the company. Dividends paid by the companies in UK has dipped to around 36% from the end of 2007, and it will be even more down to a massive 50% if the dividends paid by Tobacco & oil industries is excluded. Even the most defensive stocks have failed to sustain in these times & give good returns. At these times, the dividend payouts have fallen from these companies. This has created a situation where the mutual funds, which focus on such established companies, have fallen in value, as they are not able to maintain their annual and regular dividend payouts to their shareholders. The investors who have invested in these funds on a long-term basis hoping for regular income from the funds are disappointed. The average FTSE All-Share return during the 10 years following decades of low returns was a massive 14 per cent per year. Since 1962, the average annual return provided by UK shares has been almost 12 per cent (including reinvested dividends). The major companies, which pay dividends and wherein the income based mutual funds, are concentrated in the banking, financial & oil sectors. During the early part of 2008, the financial crisis has affected this traditional dividend paying and well-established companies in a major way. While the banks in United Kingdom, United States and elsewhere have been affected very badly in 2008, the oil companies, which saw enormous profits due to rapid surge in oil prices, have seen profits fall in 2009. This compounding factor has led to the decrease in dividends received by an average investor. Dividend History of Banks (pence per share)
2000 12.1 23.5 30.6 2001 17.5 27 33.7 2002 16.5 31 34.2 2003 15.7 35.7 34.2 2004 15.75 41.2 34.2 2005 17.4 17.7 34.2 2006 20.5 22.1 34.2 2007 22.5 23.1 35.9 2008 11.5 0 11.4 2009 1 0 0 (Source- Lloyds TSB, Royal Bank of Scotland, Barclays) The above graph and data shows that the dividends from the banks have sharply fallen in the recession period from 2008. According to the experts in the stock markets, the gloom of the recession has almost ended and from 2010 onwards, it is going to be a good ride for the equity markets. The fall in oil prices and the pound-dollar conversion factors are pulling down the actual dividends from the oil sector. Dividend History of Oil Companies (pence/share)
2000 98.1 14.2 55.6 2001 102.5 16.3 54.9 2002 106.2 15.4 55.6 2003 108.6 15.8 67.9 2004 110.5 16.7 69.1 2005 109.9 20.3 70.4 2006 108.6 20.8 79.0 2007 88.9 22.8 84.6 2008 98.8 32.3 95.7 2009 98.8 26.5 102.5 (Source – Exxon Mobil, Shell, British Petroleum) The fall in dividends have not affected some of the companies such as Astra Zenca, Glaxo and BAT, as can seen from the below figures and graph, that they have actually increased. This has created further confusion among the investors.
2000 60.0 49.4 29.0 2001 27.0 43.2 32.0 2002 39.0 54.9 35.2 2003 40.0 55.6 38.8 2004 42.0 67.9 41.9 2005 43.0 69.1 47.0 2006 46.0 87.0 55.9 2007 50.0 108.2 65.7 2008 55.0 120.4 83.7 2009 61.7 129.2 87.8 (Source- Glaxo, Astra Zeneca, BAT)
The dilemma of the investors is also compounded by the confused signals emerging from the market. In the early part of 2009 itself, the mutual fund managers were predicting the return of increased dividends in the same year. This has not happened and more over the income yield of 80 percent of the mutual funds have fallen in 2009. The people who clung to the equity income mutual funds were loosing hope and the same story is again repeated in now by the fund managers even if their fundamentals remain the same. The same logic of return on capital, massive profit margins and better balance sheets of the companies were predicted by the mutual fund managers in early 2009 which did not happen and the same set of reasons are being portrayed by the managers for the increase in dividends in 2010. According to Mark (2008), the patience is the virtue required by the investor in an income mutual fund but this seems to have evaporated in 2009. But both the fund managers and the investors who clung on to their favoured stocks of banks, financial institutions have been disappointed. Even though the companies in the traditionally lower dividend disbursement areas of mining and energy sectors have performed well in 2009, the income funds did not have exposure to this area of the market. Traditionally equity income funds were seen as less risky but in 2008 the market scenario changed to make investment in income funds as risky. Some of the income mutual funds did yield over 6 percent yield like Liontrust, Standard Life Investment, and Schroder’s Far East Income etc. The dividends of funds that concentrate on stock markets outside the United Kingdom have seen a balancing and even in some cases an upward swing even though not according to the historical levels. The indication of the market and many experts is that the investors give more attention to the growing and strong Asian and European markets. As an example Newton’s Asian Income fund registered a quarterly dividend yield of 5.18 percent and is about 10 per cent increase from last year and the 5.14 per cent quarterly dividend payout of Sarasin International Equity Income fund is an increase of 12.46 per cent (Kelleher 2009). Some of the other companies which are not affected by the recession is in the telecommunications, pharmaceuticals sectors. As an example Vodafone is expanding its markets in the asian region more than the European and American continents and seen the profits ad the corresponding dividends increase.
Year ended 31 March
2010 2.66 3.5 2009 2.57 5.2
3.5 2008 2.49 5.02
11.1 2007 2.35 4.41
11.4 2006 2.2 3.87
49.14 2005 1.91 2.16
100 2004 0.9535 1.078
20 2003 0.7946 0.8983
14.99 2002 0.7224 0.7497
5 2001 0.688 0.714
5.01 2000 0.655 0.68
4.95 1999 1.2720(1)
(Source – https://via.vodafone.com/start/investor_relations/shareholder_services/ordinary_shareholder/calculator.html)
As per a recent report from Bloomberg News, a positive forecast of dividend payouts in the S&P 500 is expected for the financial year 2010. Bloomberg noted that one in six members of the S&P 500 may raise their next dividend payout while only 2 percent is going to cut it down compared to the previous payouts. Adding to this, S&P also released a positive forecast for dividend increase of up to a 6.1% rise in 2010, after a massive decline of 21.4% in 2009. The total dividend cuts in 2009 were amounted to around $48bn, with 78 dividend cuts. But in reality, looking at the historical growth rate of dividend payouts of S&P, being at 5.6%, and the huge losses & downturn in business conditions due to recession in the last couple of years, the 2010 forecast doesn’t project a much brighter image. Following the slightly settled conditions of the fallouts in 2009 & the expected economic recovery in 2010, with companies slashing costs & hoarding capital, a full-fledged comeback is not expected to hit until 2011. Following the near-collapse of the entire financial system across the world, companies have undertaken severe cost cuts & highly conservative financing for healthy balance sheets & improved profit margins. Most of the near-fallouts who were able to sustain through these times with the help of bailouts from the government have repaid their loans. However, the S&P 500 companies will be cautious with dividend increases, with companies such as Telecom giants – Verizon Communications & AT&T, IT companies like Intel & Microsoft, which maintained a flat level in 2009, until the concerns over the recent regulatory changes, Income & bonus payments, capital requirements etc clears. However, on the flipside, as per Markit survey, few companies like JP Morgan, Morgan Stanley, BB&T etc, along with few IT companies, are not going to be held back by such concerns. Overall, the dividend recovery in 2010 financial year is going to be very gradual. Markit also expects the healthcare industry not to be concerned about cutting their dividend payouts due to the federal health care reform, rather this industry is going to see an upturn in the dividend payouts with companies like Pfizer increasing it to 12.5% (ie., 18 cents / share) and Johnson & Johnson continuing with its historical pattern of increasing dividends. But, the recent recession, coupled with elevated unemployment rate is expected to hamper the dividend pay-outs in the retail industry, with only 9 dividend increases in the S&P 500 for the 2010 year, but on the positive side, only one decrease & no suspensions are announced till now. Also, the tax changes & VAT rise hampered the consumer confidence to a greatest level. However, higher dividend payouts always lead to a fall in the company share price. The other two industries, which are believed to be cheaply valued & are expected to perform well in 2010, are Pharmaceuticals & Utilities. Market expects these & other defensive sectors to show promising returns in 2010. The one sector in S&P 500 that showed a consistent higher dividend payout is the consumer staples. Out of total 34 dividend declarations made by the companies in this sector, 33 were increases. This sector is again expected to take the lead & continue giving higher dividend returns to its investors.
Altria 6.90% Kimberly-Clark 3.80% H.J.Heinz 3.90% Kraft 4.30% Oil-Dri 3.90% Data from Yahoo! Finance and CapitalIQ, a division of Standard & Poor’s, on Jan. 5.A The current yield on FTSE 100 is only at 3% but when the economy takes a full upward turn in 2010, with simultaneous rise in share prises, it is expected to yield a decent overall return in the coming years. Few stocks are expected to give long-term consistent higher dividends, while a few others will be focussing on initial dividend yields. So, the investors are advised to include both the types of stocks in their portfolios in order to achieve growth and stability of their dividend yields. Following five companies have proven to be yielding good long-term annual growth in dividends, with a fairly decent dividend cover forecast for 2010. Company Prospective Dividend Yield Annual Dividend Growth 5 years Prospective Dividend Cover Domino’s Pizza (LSE: DOM) 2.7% 40% 1.7x Mitie Group (LSE: MTO) 3.2% 22.5% 2.3x Connaught (LSE: CNT) 1.0% 14.5% 7.6x Tesco (LSE: TSCO) 3.1% 11.8% 2.3x Imperial Tobacco Group (LSE: IMT) 4.4% 10.9% 2.1x On the other hand, the below table gives five stocks which are among those whose earnings are recorded to be stable. The forecast for them for 2010 is as good as the previous ones, as they can cover their dividends with ease. Company Prospective Dividend Yield Prospective Dividend Cover HMV Group (LSE: HMV) 7.8% 1.8x BP Group (LSE: BP) 5.7% 1.8x Vodafone (LSE: VOD) 5.6% 1.8x Vislink (LSE: VLK) 5.6% 3.7x Royal Dutch Shell (LSE: RDSB) 5.6% 1.8x Inflation is the other factor that will affect the dividend payout returns for investors. The increase in inflation will make the dividends even more attractive. As the UK dividends are taxed quite generously by the government, compared to returns on cash savings or FI based on the fact that the company have already paid tax on its earnings. However, the recent increase in tax from 32.5% to 42.5% for dividend income > £37,000, it is also expected to have a nominal effect on the dividend returns. As they are reading daily news about major companies slashing their dividends, Investors have lost confidence in the equity income market and equity dividend as they feel that it will be a while before the dividends of the companies start climbing up. The fund managers of equity income funds are really confident about the prospects of the markets and especially the dividends income they will be able to generate by restructuring their investment portfolio. The lack of investor confidence is the result of the fall in the average yield of United Kingdom stock market which is down by 3.5 percent. But investors are needed to clung on to their investments or start reinvesting for them to actualise the long-term average return.
During these uncertain economic scenario the investors and the fund managers need to change track if they have to keep their investments safe. The income mutual funds may see an increase in income due to the increase in dividends as the economic climate is slowly picking up. A certain level of uncertainity remains in the market and the confidence levels have not returned. The banking and financial sector is still weak and need further time for consolidation. Till that time it is expected that they will not be able to provide the kind of dividends they were paying the investors before. The mutual fund managers need to make change in portfolios to companies in the Asian and other emerging markets which are growing at an even pace. The companies in these markets have not been as affected by the recession as in the United Kingdom. The investors on the other hand might need to think about investments in growth oriented mutual funds to capitalise on the growth trend in the stock market.
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