Income is a growing necessity in the current high-inflation environment but there is some debate as to whether investors should put their eggs in high-yielding stocks, or plan for the future on those that can grow over time.
Turning to history for guidance, in the 1970s, only company dividends were able to keep up with inflation, which could be one of the reasons behind today’s renewed interest in investing for payouts.
However, higher yields tend to signify that investors are pricing in more risk, but with strong potential gains for taking this on. Using yield as a starting point, for those investors willing to take the plunge the UK is a tempting proposition as it has the highest yield across all major regions, as the table below shows.
Source: RBC Brewin Dolphin
Kate Marshall, lead investment analyst at Hargreaves Lansdown, said there were reasons for optimism that despite concerns around anaemic economic growth, rising inflation and interest rates and political instability, the market could be coming into its own.
“While the UK has faced headwinds this year, the FTSE 100, which features the biggest dividend payers in the UK market, has held up better than most global markets. The UK is out of favour with many investors, but we expect it to remain a place for income over the long run,” she said.
Alena Kosava, head of investment research at AJ Bell, said the market has indeed struggled over the long term due to material exposure to cyclical sectors, which were hard hit through the pandemic but have subsequently benefited from a re-opening in the global economy.
“In the case of both Europe and the UK, banking names were some of the top performers, benefiting from the easing of regulation around dividend payouts. This allowed for income to be distributed to investors, thus reversing constraints suffered by banking stocks through the pandemic,” she said.
“Other top performers include the oil and broader commodity sector stocks, which dominate the UK market.”
However, there are concerns that this environment may not last forever and Kosava warned that investors should be mindful of dividend concentration around the UK, as market dividend concentration remains material.
David Cadwallader, investment manager at wealth manager RBC Brewin Dolphin, looked beyond the UK’s attractive dividend figures and noticed that these aren’t always the result of strong fundamentals.
“Dividend yield alone can be problematic, as it is calculated simply by dividing the dividend per share by the price per share. The yield could rise simply because a share price has fallen – often a sign of a company in difficulty and a potential dividend ‘trap’,” he said.
“This is why we tend to focus more on earnings growth and cashflow, as companies that can demonstrate these strong fundamentals over a sustained period of time are more likely to grow their dividends over the longer term.”
Dividend growth across the UK has been quite muted in the past decade, with some of the biggest companies in the UK market having pushed through significant dividend cuts in recent years, including the likes of HSBC, BP and Shell.
The picture looks different in the US, where there has been very strong dividend growth over the past decade, despite it being perceived as a low dividend-paying market.
“Indeed, there are a host of stocks in the market that have outstanding long-term track records of growing dividends, including Johnson & Johnson, Coca-Cola, Colgate-Palmolive and Proctor & Gamble, all of which have increased their dividend distribution year-on-year for more than half a century,” said Cadwallader.
“At an index level, US dividends have increased by 115% over the past decade, in part driven by significant growth across parts of the tech sector. Microsoft has increased its dividend by 169% since 2013, and Apple has more than doubled its dividend distribution since 2012.”
Europe and Asia both offer dividend yields around the 3% level and have experienced stronger dividend growth than the UK in recent years, but Marshall was sceptical, especially towards the latter.
“An increasing number of companies based across Asian and emerging markets have started to pay dividends over the years. However, yields move inversely to share prices, so it’s worth noting that as Asian and emerging stock markets have fallen in value this year, this has seen relative yields increase,” she said.
“Emerging markets (ex. Asia) have somewhat surprisingly also delivered stronger dividend growth than the UK over the past decade, and currently offers a dividend in excess of 6%.
“However, this particular index is even more skewed towards a narrow list of sectors including energy and mining, and stocks such as Vale and Petrobras, both of which currently trade on double-digit dividend yields.”
Investing for dividends internationally isn’t more straightforward than focusing on the UK alone. Yields will change over time depending both on share price movements as well as the level of dividend growth (or lack thereof) from individual companies.
“While the UK and emerging markets currently look to be the highest-yielding markets, the level of income received will also depend on the ability of companies to increase earnings and pay dividends,” Marshall noted.
On top of that, each market or region typically has its own headwinds at any given time, said Cadwallader.
“However, looking beyond the UK and investing in dividend-paying stocks on a global basis means that you have a much broader set of sectors and a deeper pool of companies to consider.”