Finding income in uncertainty

With the stock market volatile and the cost of living rising, figures from Link that show that dividends paid to shareholders have dropped by a quarter look like more bad news.

Although the 24.9 per cent fall in dividend payouts in the first quarter is alarming, it masks some good news that illustrates the importance of income investing.

Many shareholders rely on regular dividend payments on the stocks they hold, whether they invest in shares directly or through funds pooled with other investors. With interest rates still way below inflation, despite this week’s rise, they are an important way to help wealth keep pace with inflation.

Companies often pay dividends to shareholders when they have excess cash and their profits are strong, so a fall in dividends is concerning.

However, with last quarter’s figures, all is not what it seems.

A special year

The Link Dividend Monitor is comparing dividends paid in the last quarter to those paid at the same time last year. It shows a collapse in dividend payments because of a decrease in what is known as ‘special dividends’ – those paid out in unusual circumstances.

Last year saw record amounts of these payments, as companies distributed cash that they had hoarded during the uncertain early months of the Covid pandemic in 2020.

Some companies, such as banks, were actively prevented from paying money to shareholders during this time, while others simply delayed dividends to ensure that the company was prepared for the worst. In 2021, this extra cash was distributed, leading to an unflattering comparison this quarter.

Underlying excellence

Once special dividends are stripped out of the figures, the UK’s dividend picture looks far healthier. By also removing the effect of the departure of mining giant BHP Billiton, which has merged with a private company, Link has calculated that underlying dividends rose 12.2 per cent.

All sectors increased their dividends, with the oil and gas sector leading the rise due to the increase in oil prices. Dividends in the sector rise 29 per cent, but companies in many other sectors including household pharmaceutical name AstraZeneca and communications giant BP increased dividends too.

Link has increased its forecasts for dividend payouts for the rest of 2022. It expects the UK stock market as a whole to yield 3.7 per cent – way above what you would get in a savings account and helping those with stocks and shares to counter rising inflation. The top 100 stocks in the UK which make up the FTSE 100 are expected to yield 3.8 per cent, with smaller mid-caps expected to yield 2.4 per cent.

What does this mean for us?

The Link report acknowledges that these excellent forecasts could be derailed, with Ian Stokes, Link’s managing director of corporate markets, warning that rising inflation and a possible recession could have an impact on payouts.

Mid-cap companies (those below the FTSE 100) may suffer more from this, Stokes says, but cost pressures will exist for all companies.

Meanwhile, continued inflation will squeeze the value of any savings we have tucked away in bank accounts, even though this week’s rate rise will improve the rates available.

Finding dividends from investments will be increasingly important to help ensure we hit financial goals, but with clouds on the horizon, it is important that businesses have strong balance sheets and are in the right sectors of the economy if they are going to be able to pay dividends.

Having a portfolio of the right types of investment is the key to success. Investors should make sure that their portfolios are diversified across different sectors and geographical areas, to prevent sudden volatility. It is also worth checking, if you are picking stocks for their dividends, what the dividend cover is for the payouts.

This figure measures how much of the money a company is making is paid out in dividends to shareholders, and you can find it by dividing a company’s earnings per share by its dividend per share (both should be available on the company website). If a company has low dividend cover, paying out a lot of its cash to its shareholders, it may find it harder to sustain payments if times are hard.

If this sounds complicated, there are specialist funds of income-producing shares, while your financial adviser should be able to put together a portfolio that matches your circumstances. It is also important, unless you need the income immediately, to consider whether to invest the dividends from your shares back into your portfolio, as this can have a huge effect on the value of your assets over time.