At times of market turbulence, there is one factor that undoubtedly shores up investor confidence: dividends.
During the recent turmoil, company after company underscored its financial strength by lifting its 2006 pay-out, often substantially.
Such is the largesse that Cazenove expects FTSE 100 companies to pay out a total of £53bn for 2006, up 12 per cent on last year and representing a dividend yield of about 3.5 per cent.
Add in an estimated £35bn more for special dividends and share buy-backs and the total amount paid back to shareholders will be almost £90bn, a total shareholder return of almost 6 per cent. Such a generous pay-out must limit the downside risk for the UK stock market.
And not only are dividends rising, they are beating expectations. Stewart Breed, quantitative equity strategist at Man Securities, says companies accounting for more than 60 per cent of the market capitalisation of the FTSE 350 index (excluding investment trusts) have announced their results for 2006. He calculates they will pay out a total of £35.7bn in dividends.
This is 3.7 per cent higher than the £34.5bn expected at the start of the year and compares with £31.4bn paid out in 2005. Mr Breed also expects overall market dividend growth in 2006 of about 12 per cent.
At the individual company level, some pay-outs have been particularly striking. Royal Bank of Scotland increased its pay-out by 25 per cent when it reported results on March 1.
On the same day British American Tobacco raised its pay-out by 19 per cent, increased its share buy-back programme by 50 per cent and announced it intended to pay out 65 per cent of earnings as a dividend in 2008, up from a recent pay-out ratio of 50 per cent.
Both these companies have seen their shares outperform the wider market, adjusting for the fact that they both went ex-dividend this week. RBS has produced a total return of 7.9 per cent this month, while BAT’s total return is 2.7 per cent.
Other companies to have produced positive dividend surprises in the last fortnight include International Power, Scottish & Southern Energy and Royal & SunAlliance.
Investors like cash being handed back to them. They have repeatedly suggested in surveys that they would rather companies handed back cash than spent it on acquisitions or capital expenditure.
But dividend increases are more highly prized by investors than special dividends or share buy-back programmes. There is a sense of sustainability about a higher dividend. A special dividend or buy-back programme is either a one-off or a tap that can easily be switched off.
Companies of course can reduce or even scrap their ordinary dividends but they never like to, even when earnings go down, because cutting pay-outs is one of the quickest ways to damage a relationship with shareholders. There is quite a contrast between individual sectors. Utilities, where cash flows are particularly stable and relatively easy to predict, are well known for paying out generous dividends.
By contrast, highly cyclical mining groups have been less generous with their regular pay-outs, preferring special dividend and share buy-back programmes. Anglo American, for example, has pledged to hand back an extra $3bn of cash through share buy-backs in 2007, following last year’s $7.5bn. Investors take this as a sign that commodities prices are set to fall or that companies are hoarding cash for acquisitions.
While some companies have disappointed by not raising dividends as much as expected, very few have cut their pay-outs. Rank is one of the exceptions, but its reduction to 6p from 15.3p follows a restructuring.
Some companies, which report their results in dollars, have seen the amount they pay out to investors fall in sterling terms but that is purely because of the fall in the value of the dollar against the pound.
The good news is that there is every indication that dividends will be even higher in 2007. Darren Winder at Cazenove reckons the FTSE 100 companies could pay out £55bn in dividends this year – that is based on a $1.95 exchange rate, so the figure will be even higher if sterling continues to weaken against the dollar. About one third of UK earnings are generated by companies such as HSBC and BP that report in dollars. Mr Winder also points out that the 10 largest UK companies are currently yielding more than 4.5 per cent before buy-backs, about the same as 10-year gilts. That can only enhance their attraction to investors in these uncertain times.
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