Reliable income streams are the holy grail for many investors, particularly if investments are planned to fund retirement, which is why the dividends paid out by many UK companies are watched with such care by experts and individuals alike.
Dividend payments are made by companies who want to return profits to their shareholders. They look small, but can make a huge difference to the total returns on an investment if you continue to reinvest them in your portfolio. Alternatively, they can be a source of reliable income without dipping into one’s capital, particularly important when bank rates are low.
The coronavirus dividend income collapse
When coronavirus hit, one of the first things that companies did was cut dividend payments. Figures from Link Group, which compiles a quarterly dividend monitor, show that payments collapsed by nearly 50 per cent in the second quarter of last year.
Some feared that a dividend-paying culture would never return, but there is encouraging news from recently published first quarter figures for 2021.
While dividend payouts have continued to fall, this decline is slowed, and in Q1 underlying dividends (these exclude one-off special payments after mergers and acquisitions, which can distort figures) were down just 27 per cent on the previous year.
Next quarter looks set to be even healthier, as more businesses that previously cut dividends, including Primark’s owner Associated British Foods, which reinstated its dividend last week, start paying out again.
What happens next
Link managing director Ian Stokes is positive on the dividend picture for the this and next year, even indulging in a Boris-Johnson-like metaphor for the payments: “After the year-long pandemic winter for dividends, the buds of spring are about to burst into bloom,” he says.
Britain’s banks are expected to start paying dividends again, from a lower base, while Link expects a growth in mining dividends too, thanks to a boom in commodity prices. Although Link still cautions that it will take until 2025 for dividends to reach their 2019 high point, this is good news for income seekers.
Why you should care about dividends?
Understanding the role dividends pay in growing your wealth is important. Depending on the investment strategy for your portfolio, these payouts may be very important or not as vital to how your portfolio grows.
Investors need to understand how safe their dividends are. The coronavirus pandemic is a one-off event that has hit many payments, but it is often possible to work out whether a company’s dividend policy is sustainable by looking at a measure called ‘dividend cover’. This shows how much of a firm’s profits are going into dividends payments.
On the other hand, just because a company does not pay a dividend does not necessarily mean it is a bad investment. Some companies use their cash to invest and grow, and your portfolio will benefit from a growth in share price as this happens. Similarly, other companies might give back profits to their shareholders via a different mechanism known as ‘share buybacks’, where they use the money to buy their own shares, thus pushing up the price for their investors.
The value of expert advice
If you involve expert advice, such as from a financial adviser or investment manager, they will be able to deal with the intricacies around managing dividends, ensuring that your portfolio still produces an income for you if necessary.
This may involve changing the make-up of your investments and focussing on those businesses and sectors that are still highly cash-generative, and likely to reinstate or continue to pay dividends in the near future.