Globally, quoted companies paid out a record $1 trillion in dividends last year according to the Henderson Global Dividend Index, a research report that tracks dividend income from the world’s listed companies.
With annualised growth in the total dividends paid of 9.4% since the 2009 market lows, we believe there is plenty more to come.
Companies increasingly recognise the benefits of attracting investors by being able to demonstrate a strong and growing dividend policy as part of their shareholder return policy. This is well-established in Europe and the US, but the dividend culture is now providing increased opportunities in regions such as Asia-Pacific and selected emerging markets. This broadening universe provides an attractive opportunity-set for equity income investors.
Long-term outperformance
Studies indicate that dividends have generated a significant proportion of the total returns from equities over time. As the chart below shows, the combination of reinvested income with potential capital growth has led to long-term outperformance of higher dividend-paying companies compared to the wider equity market.
Reasons for this outperformance include a focus by company management on increasing the levels of surplus cash generated, in order for dividends to be sustained. Dividends also act as a useful indicator of the underlying health of a business, and the capital discipline that a policy of paying dividends imposes on a company’s management team can improve decision making. A sharper focus on cashflow can reduce the risk of business failure and a misrepresentation of earnings in the company accounts. In addition, higher yielding shares by their nature tend to be out of favour, which can offer potential for an upward re-rating in the share price when positive investor sentiment towards the company returns.
Risk reduction – diversification benefits
As more companies globally pay dividends, the potential to diversify increases. Some markets suffer from dividend concentration (a significant portion of the market’s total dividends coming from a small number of companies or sectors) and as a result equity income strategies focused on single countries risk dividend cuts if any of the big dividend-paying companies or sectors struggle. A global remit also maximises the opportunities at a sector level; for example, many high yielding technology companies can be accessed through investing in the US or Asia, but there are few such opportunities in Europe.
Look beyond the headline yield
The dividend yield is calculated by dividing the annual dividend by the share price and multiplying by 100 to reach a percentage figure. History shows that dividends from the highest-yielding stocks are often unsustainable, with an estimated yield above 5% less likely to be realised. This is because a very high yield can often be symptomatic of a company that is struggling, and it is the company’s weak share price that is causing the yield to be high. Such companies are often only a step away from cutting their dividend. A successful strategy therefore looks to balance investments in businesses that offer an attractive yield with opportunities for dividend growth, while also ensuring cashflows remain sustainable with good dividend coverage (the number of times that a company can pay this year’s dividend from this year’s earnings).
Dividend outlook
The level of dividends paid by quoted global businesses has been growing and this is forecast to rise further as the health of companies continues to improve. At a stock level it is possible to find companies in markets around the world expected to increase their dividends by around 7-8%.
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