Andrew McMenigall, senior investment manager on the Aberdeen World Growth & Income fund, looks at the opportunities a shared global dividend culture presents...
Dividends have always provided investors with a steady stream of income.
In recent years, with interest rates at rock bottom in developed economies, investors have appreciated the benefits of higher dividend yields. This is not only because of the equity income they offer, but because being able to pay a steady dividend has been an important signal of corporate health and confidence in difficult markets.
But, as UK companies cut dividends to conserve cash, or became insolvent – as RBS or Lloyds did – during the credit crunch, investors left with increasingly concentrated portfolios have learnt the value of diversification the hard way. The aggregate dividend payments paid by UK companies fell by 15% in 2009 and, following the loss of BP’s dividend payments after the Gulf of Mexico oil spill, total dividend payments fell another 3.3% in 2010, according to Capita.
Why the UK no longer stands alone on dividends
Just how concentrated UK portfolios are at the moment can be appreciated by considering that, according to Capita’s latest Dividend Monitor, the top 15 dividend-paying FTSE 100 companies accounted for 68% of total payouts in the third quarter of 2012. Similar figures apply when you analyse previous years’ data.
Searching for income abroad
Understandably, an increasing number of investors are now broadening their horizons and looking for equity income abroad. Investors used to focus on the UK’s long-established dividend culture, where dividends were less likely to be cut than in other countries when the going got hard.
But dividend culture is becoming increasingly prevalent outside of the UK. It is well established in the US and most of Europe, where companies understand shareholders’ demand for dividends and the need for disciplined capital allocation in order to meet their objectives.
Indeed, contrary to received wisdom that dividend yields are higher in the UK than in Europe, the two markets are actually comparable. European firms pay dividends just as reliably as UK companies do. And while capital gains and share buybacks used to be preferred in the US to dividends – which were taxed at a higher rate – tax reforms in recent years are slowly changing US investors’ attitudes to dividends.
Meanwhile, Asian companies embraced dividends long ago in order to attract investment funds and, as a result, a dividend culture is gradually establishing itself – though it varies across the region. A sign of how seriously Asian firms take equity income clientele is that payouts soared in early 2009 because companies there maintained their dividends even though earnings plummeted.
Firms in emerging markets, like Latin America, are also increasingly using their earnings to return value to investors. Take Kimberley-Clark de Mexico, the leading manufacturer of paper-based household products in Mexico.
It has used the strong cash flows it enjoys, by virtue of supportive demographics and consumers trading up to better quality products, to consistently grow its dividend over the past five years. With growth opportunities in emerging markets seen to be superior, higher dividend payouts might be expected across these regions in the coming years.
However, high quality firms with strong balance sheets and the cash flows to invest in business growth and to return value to shareholders can be found globally. The key virtue of a truly global equity income portfolio is that the dividend paying companies in it will include businesses from a wider spectrum of sector exposures, offering obvious diversification benefits.
While the oil, gas and mining sectors tend to be high-yielding in the UK, in Europe it is more skewed towards industrials, pharmaceuticals, utilities and telecoms. In emerging markets, well-run infrastructure firms with sustainable business models tend to be cash generative.
According to Société Générale, payout ratios (i.e. the amount of earnings paid out in dividends to shareholders) grew faster in Europe than they did elsewhere last year. They now stand at well over 50% compared to figures of 30%-40% for the US and emerging markets.
Payout ratios in the US, which have been falling for the last 20 years and fell sharply at the end of 2011, are now 30% on average and showing initial signs of recovery. But having scrapped dividends as business confidence fell in the downturn, corporate cash in the US has risen markedly in the last couple of years.
Latest Factset figures for the third quarter of 2012 show that the dividend yield on the S&P 500 is still a measly 2.1%. However, if the recovery in the US takes hold, dividends might start to grow again.
What is certain is that there is an increasingly global dividend culture today. By screening for shareholder friendly companies with robust underlying cash flows, it is possible to find companies with the scope to deliver dividend growth anywhere.
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