When It Happens Panel Get involved: send your photos, videos, news & views by texting 'OXFORD NEWS' to 80360 or email
Does the economic crisis have a silver lining?
Perhaps the greatest corollary of the protracted financial crisis has been the maintenance of corporate profitability. Though capital investment and recruitment may have been sidelined, many leading companies continue to report impressive profits and set dividend payouts at levels comfortably covered by earnings.
It follows that despite volatility becoming an unfortunate byword for equity markets, first rate organisations such as Royal Dutch Shell, Vodafone, BAT and HSBC, continue to attract significant flows of investors’ money.
Other businesses, including First Group and Greggs, are committed to increasing their dividends year-on-year while organisations such as Pennon are also worthy of note.
Pennon recently announced that while it currently had one of the lowest prospective yields (3.9 per cent) in the water sector, it plans to increase the payment by the retail price index plus four per cent a year, substantially boosting dividend returns.
This is nothing new. Ordinarily, dividends might be maintained during periods of economic volatility even if they exceed free cash flow.
The decision to do so is often an expression of confidence by a company’s board, but currently, even while economic conditions deteriorate, many businesses are steadily increasing dividends as they are comfortably covered by earnings.
Temporary adjustments to cash flow rarely result in changes to dividend distribution. Only if such changes are likely to be permanent will management amend its dividend policy.
And if management considers fresh investment opportunities as being low-risk, they can be financed with debt, so enabling dividends to remain untouched.
Conversely, if any new opportunities are considered risky, it might be deemed prudent to finance them by reducing the short-term dividend payable to shareholders.
Such a strategy should theoretically enhance future cash flow and boost equity value for investors.
But investors who buy shares with above-average dividend yields and deteriorating fundamentals are creating a rod for their own back because the payouts are always likely to be slashed.
The same applies to companies paying dividends from the proceeds of newly-issued equity rather than free cash flow.
Currently investors are seeing companies with significant volumes of cash available for distribution steer clear of investment opportunities, either because what is on offer is too risky or too expensive. As a result, dividend payouts are rising.
That means the willingness of boards to either return cash to investors as dividends or embark on a share buy-back spree has created an opportunity for investors to ‘lock in’ some attractive returns.
Today, around 30 per cent of the UK’s top 200 companies pay an annual dividend of more than 4.5 per cent.
A significant proportion of investors are content to invest in these businesses, re-invest the proceeds every year and so enjoy compound interest.
The process builds equity stakes by forfeiting the cash benefit provided by the dividend.
Although the economic outlook remains under a cloud, investors gradually securing decent, long-term dividend payments may consider their strategy to be a silver lining.