As bond yields and deposit rates fell, one product did pay dividends
Investors have turned to dividends which have been rising globally but the risk does need to be spread
Michael O’Leary: under his stewardship Ryanair has offered an attractive dividend yield. Photograph: Dave Meehan
For income-hungry investors, plummeting bond yields and deposit rates over the past few years have meant they have had to look for returns elsewhere. Thankfully, dividend paying equities have stepped into the breach, yielding payments of 4 per cent or more as well as offering investors the potential of capital gains. But does the bullish dividend yield environment still have time to run?
Dividends are payments a company makes to reward its shareholders. You can tell what a stock’s dividend yield is by dividing the annual dividend rate by the current share price – while a higher yield is typically better, this may mean the share price has fallen recently and may also be a sign of distress. Typically, you could expect more capital appreciation from companies that don’t pay dividends, but reinvest all cashflows into the business.
A major advantage to an investor of getting dividends is the impact reinvesting them can have on your portfolio. According to Ned Davis Research, an investor putting $10,000 (€7,424) into dividend paying stocks in 1969 would have since grown their portfolio to $753,092, based on this. Those who took their dividend would have only achieved growth of $201,982.
Globally, dividends have been rising. Since 2009, the S&P High Yield Aristocrats index, which tracks the performance of companies in the S&P Composite 1500, which have consistently rising dividends every year for at least 20 years, has grown at an annualised rate of 14.82 per cent. Apart from equities, investors can also consider real estate investment trusts (Reits) which invest in property. Irish Reits are yielding about 6 per cent for example.
Unsurprisingly then, money is flowing into high-yielding dividend stocks. Eleanor Hope Bell, head of UK SPDR ETFs with State Street Global Advisors, for example, notes that some $400 million has been invested in its US dividend product – which tracks the aforementioned aristocrats index – so far this year.
“People have realised that they’re not getting money from bonds or savings and that some equities can deliver you a 3-4 per cent yield. Meanwhile, they can also benefit from the recovery in economies around the world through a bit of capital appreciation,” says Kevin Troup, investment director with Standard Life in Edinburgh, adding, “and there is still a good positive outlook for dividend investing”.
Indeed a recent survey in the UK from data firm Markit pointed to a 5 per cent jump in dividends from Britain’s 350 largest listed companies this year, with a 9 per cent rise predicted for 2015. And this is not factoring in Vodafone’s exceptional dividend earlier this year. According to Markit, the top five dividend payers all have “projected yields” of more than 4.5 per cent, with pharma group GlaxoSmithKline, for example, yielding 5.2 per cent current share prices and HSBC Bank expected to increase its payment by 2.3 per cent to yield 5.2 per cent.
Why such a buoyant environment?
As Troup explains, companies with excess cash can reinvest this in the company by spending it on increased capital expenditure or M&A – but while there may be signs of a re-emerging M&A market, many companies are asking themselves ‘what will we do with our cash?’.
This is leading an increasing number to reward their shareholders by way of a normal or special dividend. Earlier this year for example, Irish investors benefited when Vodafone sold its US business to Verizon by way of a special dividend.
Indeed some 84 per cent of stocks in the S&P 500 pay dividends, for example, with an average yield of 2.2 per cent.
“Shareholders have got used to it, and companies have got used to it,” says Troup. “US companies in the past would never have dreamed of paying or growing dividends, as they could use the capital much better by acquiring or growing.”
“There is also a population demographic piece to this, because an aging population means that some investors are no longer at a wealth creation phase, so the need to draw down income is there,” says Hope Bell, noting that this demand for income is sustained.
Investors can access dividends in a number of ways. First, they can stock pick and build up a portfolio of out-performers, and either spend their dividend or re-invest it in the stock. Noel O’Halloran, chief investment officer with Kleinwort Benson Investors in Dublin, cites Seagate Technology as having a particularly attractive dividend yield, and as it’s also doing buybacks, the shareholder is getting three sources of return. Ryanair is another strong performer, having paid out special dividends, done buybacks, as well as growing its dividend.
One of Standard Life’s top picks is chemical company Lyondell Basell. It grew its dividends by 25 per cent at the start of 2013, and at the same time its share price has soared from $40 to $100.
However, as investors who were dependent on their dividends from AIB and/or Bank of Ireland to provide an income in their retirement unfortunately discovered in 2008, when the banks cancelled their dividends, relying on a couple of names may be risky. While cancelling a dividend may be infrequent, companies may cut, or stop growing their dividend, which can be damaging if inflation takes off.
“I’d encourage investing in a basket of stocks rather than individual names,” says O’Halloran.
Another approach is to opt for a fund or exchange-traded fund (ETF) that has a strategy of investing in stocks that have a history of growing their dividends. A dividend fund may reinvest the proceeds of dividends back into the fund, and so an investor’s return is based both on income and capital growth. Alternatively, the fund or ETF may pay out an income to you.
You can also hedge your risk while benefiting from dividends. Davy for example has adapted its High Yield fund to a defensive product, which allocates additional income it generates from selling call options on some of the stocks to an insurance product which helps protect it against significant market falls. Its one-year return however – 1.5 per cent – dwarfs that of the regular fund – 9.3 per cent. But how do you spot which companies have the potential for above-average dividend yield growth?
“We look wherever there is opportunity, we don’t want to get tied down to any particular sector,” says Troup, adding that the fund manager’s approach comes down to picking companies that not only pay a decent dividend, but that are also growing their dividend yield.
“It’s a big no no for us to pick a company that has cut its dividend,” he says, adding that a good predictor for future dividend yield is cash projections. “Where balance sheets start to become too strong, there is a high chance that it will come back to shareholders,” he says.
Research from State Street shows that the impact of a company cutting its dividend may be surprising however.
“If a company in the US has a dividend cut, it’s like a death sentence. But one of our core findings is that when a company in Europe has a dividend cut, it doesn’t have the same signal,” says Bell.
O’Halloran suggests a “total return strategy”, agreeing with Troup about looking for companies that are growing their dividends. “If economic growth gets much stronger you’d expect inflation to be higher also. This is why I’d emphasise dividend growth as well, because it gives you inflation protection.”
But while the outlook may be strong for dividends, there are still risks on the horizon. As O’Halloran notes, if the economic recovery was to was to derail then equities are vulnerable. “But I don’t believe it will come through,” he says.
“What you’ll start to see as M&A picks up, is that expenditure plans pick up and the first knock-on effect is that we won’t see as many special dividends as we’ve seen in the past,” says Troup.
“However, even in that scenario, companies have gotten into the mind-set of paying an increasing flow of dividends to shareholders. We think there’s been a change in attitudes. We still see growth even if M&A and investment opportunities come along.”
Dividend yield performance: Top stocks in FTSE 350
Soco International Plc 9.99%
Phoenix Group Holdings 8.29%
Morrison (Wm) Supermarkets Plc 7.35%
Vodafone Group Plc 7.19%
Antofagasta Plc 6.98%
Tullett Prebon Plc 6.73%
Ladbrokes Plc 6.60%
Friends Life Group Ltd 6.41%
Berkeley Group Holdings Plc 6.27%
Balfour Beatty Plc 6.22%
Source: Morningstar July 2014
Dividend funds:The options
ZURICH LIFE DIVIDEND GROWTH FUND
What does it invest in? “International equities, the dividend yields of which tend to be higher than their markets’ dividend”. The fund generally holds between 100-180 stocks.
Top sectors: Financials (35%); industrials (17%); consumer services (12%).
Annualised five-year return (April 30th): 16.3%.
HENDERSON HORIZON FUND – ASIAN DIVIDEND INCOME FUND
What does it invest in? The fund seeks an above-benchmark dividend yield from a portfolio of Asia stocks with a focus on value and long-term capital appreciation. A least two-thirds of the fund’s total assets will be invested in Asian equity securities and equity instruments.
Annualised five-year return (July 15th): 10.3%.
DAVY HIGH YIELD FUND
Provider: New Ireland.
What does it invest in? Stocks which historically pay higher than average dividends. It has 54 holdings.
Annualised five-year return (July 15th): 14.4%.
Dividend yield: 3.1%.
SPDR S&P DIVIDEND ETF
Provider: State Street.
What does it invest in? Seeks to provide investment results that correspond generally to the S&P High Yield Dividend Aristocrats Index.
Annualised five-year return (June 30th): 19.09%.
Dividend yield: 2.23%.