When thinking about income, yield is a great building block of total return, but it is growth in income that really drives share prices. 
Without growth in dividends, a share is ‘just a bond’. So it is good news that dividend growth in the UK is forecast to be 9 per cent this year. However, there are two snags.
Firstly, a good chunk of this growth is the continued impact of the weakness in the pound triggered by the Brexit referendum result last June. For example, in sterling terms the dividends of the oil & gas producers sector are forecast to be up nearly 7 per cent in 2017.
However, we know that the major companies in this sector, BP and Royal Dutch Shell, declare their dividends in US dollars and are doing all they can just to hold their dollar dividend flat. Growth in dividends in dollar terms is almost zero.
This is not to say that the benefit to a UK investor is somehow not real, but it will annualise out now that it is more than a year after the referendum vote. Unless you think the pound is going to collapse again, then that is the end of that.
Secondly, there is an increasing move away from progressive dividend policies. There was a time when most companies aimed for their dividend to be “progressive”, which meant that they planned to put the dividend up a little bit each year, in a steady way. In tough years this could mean that dividend cover would run down, in the expectation that cover would be rebuilt in the good times. This was thought to be desirable because it took out the bumps in the road for investors, and, in theory, a steadily growing income stream should be highly valued by the stock market.
Harsh reality has proved this approach to be unsustainable, particularly in more cyclical businesses. Miners and banks could not carry on nudging their dividends forward whilst profits collapsed. Ultimately dividend cover became too tight, or even non-existent, and dividends were cut.
The intriguing thing is that much of the forecast dividend growth in the UK is coming from sectors that cut their dividends during the last down turn.
For example, Citi estimate that around a quarter of the total growth in dividends of the whole market can be attributed to the mining sector.
These companies all cut their dividends in 2015-16, but as we have recently seen from Rio Tinto and Anglo American, they are keen to pay dividends now that commodity prices are off their lows and debt levels have been reduced. Having learnt the hard way, these companies no longer aspire to pay progressive dividends.
Instead their dividends are based on a percentage of earnings, or pay-out ratio. If profits are really good, perhaps there may be a special dividend on top. For instance, as recently as August 2015, Rio Tinto talked about how their “decisive actions” meant they could “maintain our commitment…[to] our progressive dividend policy”.
However, six months later the towel came in and they admitted, “that maintaining our progressive dividend policy would constrain the business”. In February 2017, as the outlook improved, they confirmed that shareholder returns would be in “a range of 40-60 per cent of underlying earnings in aggregate”.
This move from progressive to pay-out based dividend policies is undoubtedly sensible because it means management of these companies accept the reality of their earnings’ volatility. The downside is that investors no longer get a smooth ride. Rio’s adjusted earnings per share so far this decade have varied from $7.58 to just 68c.
Applying the mid-point of their pay-out range and using today’s share price and currency, this amounts to a dividend yield that swings from 0.7 per cent to 8.1 per cent. This makes it much harder for savers and investors to plan the level of income they may earn from the market year-to-year.
Next year, the situation may become even more acute. According to Citi’s forecasts, nearly half of the expected total dividend growth for the stock market 2018 is expected to come from the banking sector as dividends get turned back on. Like the miners, banks are likely to favour pay-out ratio based policies, with all the volatility than entails for investors.
Equity income funds may be part of the solution here. Diversification can pool different dividend growth rates and so may reduce some of the volatility.
But, whilst many income funds trumpet their yield, fewer emphasise the dividend growth they are aspiring to, and those funds that are trying to deliver a progressive dividend will increasingly have their work cut out as the sources of progressive income become scarcer. I guess no-one said it would be easy.
Eric Moore is a fund manager of the Miton Income fund. All views are his own and should not be taken as investment advice.