Income Majors 2019

The first VOC dividend was paid in 1612 at £287.50 a share, giving a monstrous yield of 57.5 per cent on the original share price. This yield would not last, but VOC would remain a serious income stock over the course of the company’s 198-year history, with an average yield of 18 per cent a year. The dividend was payable to shareholders via a range of proxies that included VOC corporate bonds and even cloves. Along with its role in the Dutch empire, which included providing assistance to the Netherlands in its war of independence with Spain, the Dutch East India Company was a pioneer in a form of market return that is growing in favour with income-seekers, such is the current state of monetary policy.

Should dividends be spent elsewhere?

None of the income stocks featured in our Income Majors comes close to VOC’s yield. In their favour, none of them reward shareholder loyalty with spices. Over the following pages, the IC’s specialist writers examine the conditions that affect these companies' ability to maintain yields of over 5.5 per cent. The vitriol directed at dividends from some quarters could tempt these businesses to look for alternative proxies for shareholder return. Companies have paid dividends for over four centuries, but the decision to return cash to shareholders, at the cost of investing in the company or reducing a pension scheme deficit, is coming under intensifying scrutiny. 

The heat is on dividends paid by formerly government-owned utilities, like Income Major National Grid (NG), which Labour intends to nationalise, should it form the next government. Fellow Income Major BT (BT.A), meanwhile, has attracted attention in the past over the funding position of its pension scheme, which was the joint second-worst funded in the world in 2016, according to MSCI research. The Pensions Regulator said this year that dividends should not be paid if an employer is unable to support its pension scheme, while Simon Kew, head of strategy and relationships in Deloitte’s pensions practice, is convinced that “the focus on dividends and deficit repair contributions will increase”. Seven of the 10 companies featured in our majors list have deficits in their pension schemes.

And despite £2bn of cash contributions to the BT Pension Scheme in June 2018, the scheme’s accounting deficit widened from £6.4bn to £6.7bn at its full year to March 2019. At its results, the company held its dividend and declared its intention to “maintain or grow” the payout, alongside plans to accelerate investment in fibre-to-the-premises (FTTP) broadband. But BT shares fell after Deutsche Bank downgraded it to a sell rating in June, citing FTTP as a threat to cash profits. Deutsche Bank expects the necessary increase in capital expenditure to prompt a dividend cut of one-third, from 15.4p to 10.32p, in BT’s full-year to 2021. At current share price levels, the resulting yield at the low end of 5 per cent would see it drop out of our Income Majors list.

A record year for dividends

The case for paying a dividend from the perspective of capital allocation may well be up for debate, but for now the dividend appears alive and well. FTSE 100 companies are set to pay out a record £91.2bn this year in absolute terms, according to AJ Bell research, which would give a yield of 4.5 per cent. This is lower, however, than the £93.7bn payout forecast at the beginning of the year – Income Major Vodafone’s (VOD) decision in May to slash its dividend by 40 per cent contributed to this downward revision. Next year is expected to be another record period for dividends, with AJ Bell predicting that the aggregate FTSE 100 dividend payout will reach £93.5bn in 2020, while the aggregate dividend cover is also expected to grow again. But an aggregate dividend increase of 2.5 per cent from this year would be the lowest increase since 2010, when the total payout actually fell. This year, the Investors Chronicle has lifted its minimum threshold for Income Majors from 5 per cent to 5.5 per cent, which relegated Rio Tinto (RIO) and GlaxoSmithKline (GSK) from our list.

Dividends may well be on the up, but little has changed at a company level, according to Rupert Rucker, Schroders’ head of income solutions. Rather, a sustained period of low interest rates has forced income hunters away from bank deposits and government bonds. “For people who want income, dividend income has become materially more important than in the past,” he says. Economic growth is expected to slow, however, owing in part to declines in global labourforce growth, weak productivity growth and ageing populations, according to Schroders research. “That doesn’t mean that dividends won’t still grow,” Mr Rucker adds, “but I think the outlook for market return… will be lower than in the past.”

The case for dividends

Investors Chronicle columnist Phil Oakley recently suggested that high-quality businesses are scarce, and that the paltry returns on some stocks aren’t justifying their premia. Income may be an answer for investors, along with companies with reserved ambitions over investment. Share buybacks are also an option for businesses. But in 2006, economist Alfred Rappaport commented that prudent companies conduct buybacks “only when the company’s stock is trading below management’s best estimate of value, and no better return is available from investing in the business”. So with quality stocks currently trading at the top end, buybacks may not seem sensible at present. In the Harvard Business Review, Professor Rappaport added: “When a company’s shares are expensive and there’s no good long-term value to be had from investing in the business, paying dividends is probably the best option.”

A dividend policy needs to be understood by shareholders, though. BT may come to rue having teased shareholders with potential dividend rises, and could be faced with cutting its payout or compromising other objectives in order to maintain its pledge. It would be hard to see the latter as anything other than value destruction. In his 2012 letter to Berkshire Hathaway shareholders, Warren Buffett argued that, along with consistency, dividend policy should always be clear and rational. “A capricious policy will confuse owners and drive away would-be investors,” he wrote. One wonders how well the cloves of the Dutch East India Company would have sat with the Sage of Omaha.

*R Freedman, Introduction to Financial Technology, 2006; W Van Lent & SV Sgourev, Local Elites Versus Dominant Shareholders: Dividend Smoothing at the Dutch East India Company, 2013

Income Majors 2019

Shell’s front-loaded returns

HSBC puts investors on buyback notice

BP bets may not pay dividends

British American Tobacco: puffed-up returns

Lloyds’ finely balanced income

Glencore: high yield, higher risk

Vodafone dials back its dividend

Rising risk of National Grid dividend cut

Income cravings sustain Imperial Brands' allure

BT payout on the line