Encouraging global earnings growth, potential tax cuts in the US and valuation disparities mean the outlook for dividend growth is not as lacklustre as many investors think, according to Guinness’s Ian Mortimer and Matthew Page.
The managers, who head up the £342m Guinness Global Equity Income fund, said there are indeed stocks available that meet their strict investment criteria, which focuses on finding high-quality companies paying moderate dividend yields that are cheap relative to both the market and their own history.
This is despite the fact many investors are concerned about levels of global dividend cover, with ultra-loose monetary policy across several regions allowing companies to borrow money cheaply to pay their dividends.
“If you look at the broad picture for the outlook of dividends, what I think is most encouraging is that earnings are growing this year and analysts are upgrading their earnings estimates throughout the year,” Page said.
“If you look over the previous six years, that hadn’t really happened. Analysts were optimistic at the beginning of each year and then they bought down their estimates over the course of that year. This year we have seen the exact opposite.
“So ultimately that means better profitability; a lot of the ways companies were using to grow their dividends prior to this year was to take on more debt or to have a higher pay-out ratio. So, this earnings growth phenomenon this year is ultimately what will allow these companies to genuinely grow their dividends.”
In an FE Trustnet article published last week, Kepler Partners’ Alex Paget referred to research on the UK equity market from AJ Bell.
It found that, not only is the average dividend cover across the FTSE 100 index at 1.6x, it is even lower across the 10 largest dividend-paying constituents which have a dividend cover of just 1.1x. In total, these 10 stocks account for 58 per cent of all UK dividends.
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Source: AJ Bell Dividend Dashboard
“This leads to a very odd situation whereby there are only a few UK stocks that offer a higher yield than the index itself, and it is those stocks that arguably have the most challenged dividends,” he said.
On a global basis, however, Page and Mortimer said there are areas of the market where the outlook for dividend growth appears bright. For instance, they pointed out that US president Donald Trump’s proposed tax reforms would have a positive impact on dividend growth among many North American companies.
“Clearly in the US if you get these tax cuts coming through, repatriation of cash is a possibility for multinational companies,” Mortimer said. “Apple has around $100bn held offshore which it could bring back and would allow for either special dividends or a general dividend boost.
“Also, simply cutting the tax rate for American companies will make them more profitable and therefore there will be more scope for higher dividends.”
That said, the managers are finding fewer opportunities in the US than they are in Asia or Europe at the moment.
Mortimer and Page adopt a bottom-up approach to stock selection and will hold an equally-weighted portfolio of 35 stocks, all of which are more than $1bn in size, have a debt-to-equity ratio smaller than 1 and have 10 years of cashflow return on investment greater than 10 per cent over 10 years.
These criteria have led to the managers increasing their exposure to Asian and European equities at the expense of US stocks. Guinness Global Equity Income currently has a 48.4 per cent weighting in in the US, 19.8 per cent in continental Europe and 7 per cent in China.
“It’s not that we’re not seeing any good opportunities in the US, I think it’s because we’re being a bit more opportunistic and cherry-picking so it’s going to depend on which movements and dislocations we see in the market over the next 12 months,” Page explained.
“But certainly when you look at it top-down on valuation grounds, the US is clearly looking more expensive than Europe and Asia, although you have seen an incredibly strong run in Asia this year.
“Will that continue into next year? Maybe, maybe not.”
Performance of indices over 5yrs
Source: FE Analytics
In terms of long-term drivers for markets, Page and Mortimer said the balance sheet strength of each individual company is now more important than ever, given that quantitative easing and ultra-low interest rates have encouraged firms to borrow more.
“Companies have been able to borrow very cheaply and they have been taking on quite a lot of debt. The question is – what have they been using it for? Are they buying back shares in the US, for example?” Mortimer said.
“What we haven’t seen is much reinvestment of cash. We haven’t necessarily seen a big capex cycle – maybe that will to come through now as confidence is increasing.
“As a result, there are now a lot of companies with really quite high debt levels and quite low interest expenses. You have companies with high profitability margins compared to history.
“One of the things we are making more certain of than ever is that every company we own has to have a very, very strong balance sheet which can easily cover those interest rate payments because, if anything, it feels like we’re approaching the end of the economic cycle.”
Since its launch in 2010, Guinness Global Equity Income has returned 109.72 per cent compared to its average peer and benchmark’s respective gains of 88.16 and 117.37 per cent. It has done so with a top-quartile maximum drawdown (which measures the most money lost if bought and sold at the worst possible times), Sharpe ratio (which measures risk-adjusted returns) and annualised volatility over the same time frame.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Had an investor placed an initial £10,000 into the fund at launched, they would have received £1,487.7 in income alone.
Guinness Global Equity Income, which has grown its dividend pay-out by an average of 5 per cent each year since its inception, has a clean OCF of 0.99 per cent and yields 2.8 per cent.