Like the UK economy, dividends paid by UK companies to shareholders are firmly in recovery mode. Last week, wealth platform AJ Bell forecast that dividend payments made by the 100 largest companies listed on the UK stock market would grow by 25 per cent this year to just short of £77billion.
Although the bounce back is admittedly after the dividend decimation of last year caused by the economic fallout from the pandemic, it will be warmly welcomed by an army of private investors who depend on the income to bolster their household finances.
If AJ Bell’s financial crystal ball gazers are right, it should mean that the FTSE100 Index as a whole will deliver an annual income this year equivalent to around four per cent – a rate not available from most other financial assets, especially cash where savers are lucky if they can get an annual return of 0.01 per cent.
Hot stuff: While many investors will be comfortable holding big income-friendly stocks, an increasing number will be more selective as a result of ethical considerations
Furthermore, AJ Bell believes the recovery in dividends will continue into next year, albeit at a slower pace (2.2 per cent).
So, all good news? Well, not really. If you dig a little deeper into the wealth platform’s analysis, you soon discover that much of this year’s dividend lift will be provided by just ten companies.
These include a clutch of big banks – Barclays, HSBC, NatWest and Lloyds – which last year were leant on by the City regulator to stop paying dividends while the pandemic raged and the economy teetered on the edge of catastrophe. Also, among the ten are mining giants Anglo American, BHP, Glencore and Rio Tinto. Completing the list are BT and housebuilder Persimmon.
While many investors will be comfortable holding some of these big income-friendly stocks, an increasing number will be more selective as a result of ethical considerations. A heightened focus on environmental, social and corporate governance (ESG) issues means many investors are now shunning ‘sin’ stocks – irrespective of the juicy dividend carrots dangled before their eyes.
Although ‘sin’ is a subjective term when used in investment circles, ‘sin’ stocks tend to include mining companies (including the four just mentioned); oil and gas companies (the likes of BP and Shell); and businesses involved either in the manufacture of cigarettes (Imperial Brands and British American Tobacco) or alcohol (Diageo). All are dividend-friendly.
Indeed, last week, Shell confirmed its intention to give shareholders more cash following its decision last year to slash its dividend by two-thirds.
Dan Lane, senior analyst at share-dealing service Freetrade, says the link between ‘sin’ stocks and attractive dividends presents a dilemma for income investors mindful of ESG considerations.
He says: ‘With the FTSE100 full of big pharmaceutical, mining and weaponry businesses and vice stocks such as tobacco and alcohol, matching your morals with your money is easier said than done. Especially, given that some of the least ‘sustainable’ businesses pay some of the highest dividends.’
Among some of the big companies expected to pay dividends this year, equivalent to an annual rate (yield) of seven per cent, are ‘sin’ stocks Anglo American, BAT, BHP, Imperial Brands and Rio Tinto.
‘Is it even possible to get income outside the sectors of sin?’ asks Lane. Well, it is, although it will mean investors being more pragmatic in terms of the income they want from their shares. A little less income now, in the hope of a growing income in the future.
Andy Marsh is co-manager of Artemis Income, a £4.8billion fund popular with investors in search of income. It is currently delivering an overall income equivalent to around four per cent a year.
To get this, the fund holds some dividend-friendly ‘sin’ stocks such as Anglo American and BP in its 47-strong portfolio as well as Barclays – expected to be one of the market’s biggest dividend payers this year. It also has exposure to some big ‘yielders’ such as Legal & General (seven per cent) and Direct Line (eight per cent). Yet a key part of Marsh’s overall investment strategy is about identifying UK companies which pay a modest dividend (between two and three per cent a year), but offer the prospect of sustained dividend growth in the next three to five years.
‘As a fund manager, cashflow is everything when it comes to looking for businesses which will pay shareholders a sustainable income,’ says Marsh.
‘We want to ensure a company will have sufficient cash left over to pay dividends once it has paid all its bills and made all the necessary investment in its business to protect and grow it. Strong cashflow drives strong dividends. But if a business’s cashflow looks as if it could be compromised, red lights flash. It’s a signal that a dividend shock could be around the corner.’
Marsh says the likes of Relx and London Stock Exchange are good examples of businesses underpinned by good cashflow.
He says: ‘Although both have roots going back to the 19th Century, they have morphed – unnoticed by many – towards the new economy. They’re profitable, growing, future facing and the dividends they pay appear sustainable. They also tick all the boxes as far as ESG investors are concerned.’
FTSE100 company Relx, he says, has embraced technology to digitalise its publishing business. Meanwhile, LSE, also FTSE100 listed, earns 70 per cent of its revenue from subscriptions built around its data and analytics.
‘The digitalisation of financial markets’ data is still in its early stages,’ adds Marsh. ‘It presents a long-term opportunity as demand grows from banks, wealth and asset managers.’ Relx grew its dividend last year by just under three per cent and it currently offers a dividend yield equivalent to around 2.4 per cent. London Stock Exchange grew its dividend by seven per cent last year with Marsh predicting ‘double-digit growth’ over the next three to five years.
Both these companies appear on AJ Bell’s list of FTSE100 companies which have grown their dividends every year for the past decade (see table). Last year, this list was 24-strong, but it has now shrunk to just 15.
Russ Mould, investment director at AJ Bell, says many of these companies do not offer dividends that in terms of yield are going to set income investors’ pulses racing. But he says investors should not be put off.
Mould adds: ‘History suggests it is not the highest-yielding stocks which prove to be the best long-term investments. Defending a high yield can become a burden for a business and the strongest long-term performance often comes from firms that have the best long-term dividend growth record.’
By way of example, he points to safety equipment manufacturer Halma, which is among the 15 ‘dividend aristocrats’ listed in the table. It has increased dividends in each of the past 42 years, always by at least five per cent. Last year, the dividend totalled 17.65pence a share, a seven per cent increase on the year before. With a share price above £27, the dividends equate to a yield of just 0.6 per cent.
Mould says: ‘Halma’s share price was 1.9pence at the start of 1979 when its dividend growth streak began. So this year’s forecasted dividend of 18.5pence looks pretty good against that.
‘Its current share price represents an astonishing capital return over the past 40 years and shows how well-run, well-financed companies can reward truly patient investors – with a combination of capital gains and income growth.’
AND DON’T FORGET INVESTMENT TRUSTS
Among AJ Bell’s FTSE100 ‘dividend aristocrats’ is Scottish Mortgage, the country’s largest investment trust.
Managed by Edinburgh-based Baillie Gifford, it has delivered 39 years of dividend growth although this aspect of its investment armoury often goes unnoticed by investors who get drawn into it because of its extraordinary investment record.
Over the past year, its share price has increased by nearly 44 per cent – 144 per cent over three years.
Yet, Scottish Mortgage is not the only stock market-listed investment trust to have a record of sustained dividend growth. It is one of 18 which have grown their income to shareholders for at least 20 years. Top of the tree are Alliance, Bankers, Caledonia and City of London which have all increased dividends for 54 years.
ONE FINAL THOUGHT ON SIN STOCKS AND INCOME
Investment expert Rachel Winter believes that investors should not automatically snub all ‘sin’ stocks when searching for income. She says many such companies are striving to change the focus of their businesses to become more eco-friendly.
Others are involved in industries which are supplying the materials necessary to reduce the world’s reliance on fossil fuels.
Winter, an associate director of stockbroker Killik, says: ‘Yes, tobacco companies are sin stocks, but it all becomes a bit more subjective when you look at other businesses such as mining. Take Rio Tinto, for example. Yes, it has been involved in some big environmental controversies, but through its mining of copper it is playing a key role in facilitating the growth of the eco-friendly electric car.
‘Similarly, while BP and Shell are still dependent on oil production, they have outlined plans to become net-zero emissions businesses by 2050.’
Winter’s preferred eco-friendly income stock is energy supplier SSE which is busy building the world’s largest offshore wind farm at Dogger Bank in the North Sea. Its dividend is equivalent to more than five per cent a year.
Some links in this article may be affiliate links. If you click on them we may earn a small commission. That helps us fund This Is Money, and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.