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Dividends are as close as stock markets get to an unbroken promise. While earnings oscillate over the cycle and buybacks often disappear when the outlook deteriorates or activist funds leave the register, dividends soldier on. Since 1965, the cash payout of the S&P 500 has never declined meaningfully in real terms. In the worst earnings downturn of that period, in 2001-2, dividends fell by just 6 per cent compared with the 50 per cent collapse in profits. So on paper, signs that dividends have been reaching record levels are welcome. From Swiss reinsurers to the US maker of Viagra, year-on-year rises of more than 20 per cent have been common in recent months.
The trouble is, payout ratios remain worryingly low. Sure, there has probably been a structural shift away from dividends to buybacks, reflecting tax regimes and the shift in incentives created by executive remuneration. UBS estimates that the world’s biggest 600 companies conducted repurchases worth the equivalent of 78 per cent of the value of dividends paid last year. But the fact remains that the payout ratio for the Datastream World index, for example, at 35 per cent, is very close to its record low. Earnings have enjoyed their biggest cyclical bounce for 50 years but companies have been reluctant to pass on the entire benefit in the form of a “permanent” dividend commitment.
The idea that low payouts reflect nervousness is corroborated by the sectoral bias in payout ratios. More than a quarter of world earnings now come from oil and gas, industrial metals, mining, general insurance and general financials (mainly investment banks). These sectors have much lower payout ratios than, say, telecoms or even pharmaceuticals. The “shortfall” in absolute payout reflects the reluctance of management teams in cyclical industries to back up bullish outlook statements with dividend growth to match. That does not mean these companies are being stingy: the big three mining companies, for example, are all conducting huge buyback schemes. But as a signal about earnings quality, it should not be ignored.