Even as Shell cuts its dividend, there were warnings from financial experts that worse news is still to come for dividend hunters and that income investors should remain measured in their approach.
Assuming that Shell sticks to its reduced quarterly dividend and that other companies who have scrapped their payouts pay nothing at all across the whole year, then the FTSE 100’s aggregate dividend is still forecast at around £54bn, according to calculations from AJ Bell, down from £75bn in 2019 and not including special dividends.
Star stock picker Terry Smith said he suspects, however, “that the really bad news for equity income investors is yet to surface”.
Dividend cover on the top 20 highest dividend yield stocks in the FTSE 100 standing at just 1.3 times earnings as of mid-April, while for the top 20 largest dividend-paying stocks in the UK it was 1.1 times.
In other words net profits are only around 10% more than the dividend.
Dividend cover cannot be sustained at 1.1-1.3 times over time for most businesses, Smith pointed out, as most companies need to keep hold of their earnings and cash in order to grow, with cover of two times considered more normal.
While many investors have been wondering when things will ‘get back to normal’, “this ignores the fact that what came before the crisis may not have been normal,” Smith said in a blog that was published on the FT and his Fundsmith website.
Directors of companies that have scrapped their dividend will “not be allowing a good crisis to go to waste and will return with a much smaller and more sustainable dividend which will mean much lower yields for equity income investors”, Smith said.
This fits in with other suggestions that the landscape for dividends in the coming few years may be altered for various reasons.
A return to previous levels of dividend payments is not likely to come without angst for any companies that have accepted government aid, from business rates, VAT relief or the furlough scheme, with suggestions that the dividend landscape may be permanently altered with less cash available for payouts due to regulatory or tax demands.
Smith — while dismissively saying that “no one should invest in equities for income” — suggested that if investors were determined to do so there were better ways to try and guarantee income, principally investing for “the highest total return you can achieve and sell whatever shares or units you need to provide cash”.
But as many investors do not like the idea of selling part of their capital to provide income, he said an alternative option for dividend income was to invest alongside a family-controlled public company.
Of the 47 stocks in the Stoxx Europe 600 that are “family influenced”, Smith pointed out that only three have cancelled or postponed dividends as the extended descendants of the business founder rely on this dividend income.
Looking at the FTSE 100, the AJ Bell analysts said the current indications were that London’s blue chips still offer a dividend yield of 3.3%.
“It is still a lot better than the 0.1% Bank of England base rate or the 0.29% 10-year Gilt yield, although it comes with capital risk and the danger that more dividends fall to economic circumstance or political or regulatory pressure,” said AJ Bell investment director Russ Mould.
Many companies are suspending their dividends for the right reasons and investors should not necessarily abandon them just for this reason, said Rebecca O’Keeffe, head of investment at Interactive Investor.
“A cut in dividends has historically been perceived by the market as a problem, and indeed companies early on in this crisis were punished (sometimes severely) for being up-front and pro-active, but sentiment has shifted somewhat over the past few weeks and we are now seeing more sense and less panic.
“However, where companies have reduced or suspended their dividends, it will leave investors having to weigh up whether this represents a prudent measure designed to tide a good, solid business over a brief period of volatility and uncertainty, or whether it is a reflection of a new post-Covid-19 world and the impact that will have.”
Noting that the term ‘income’ can sometimes be a misnomer, as total return that an investor ultimately receives should fundamentally be what matters, O’Keeffe said a temporary suspension or trimming of dividends may reduce ‘income’ in the short term, “but it is not necessarily going to harm the long term returns from a share if it is the right thing for that company to do”.
“The key to managing your investments in extreme markets is to try and make sure that you don’t rush into reactive decisions, which often prove to be the wrong thing to do, at the wrong time and for the wrong reasons.
“It is essential for investors to take a hands-on approach and make sure that you are happy that your portfolio has the balance you want and the risk level you are happy with.
“However, it does mean being measured in your approach and this is particularly relevant in respect of companies cutting dividends. Take a long-term view and make sure that where you are making changes, you are doing it for the right reasons.”