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  • UK dividend haul sets new record

    UK dividends hit record highs in the second quarter, but are future payments at risk?

    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

    The most recent Capita Dividend Monitor shows that in the second quarter of this year, the UK stock market paid out £33.3bn in dividends. That’s up 14.5% on last year and an all-time record for dividends in the second quarter.

    The recent dividend bonanza is undeniably good news for shareholders. With Capita also reporting a prospective dividend yield for the market as a whole of 3.7%, the stock market is comfortably ahead of other asset classes when it comes to generating an income. Please remember that income is variable and not guaranteed, and unlike cash, stocks & shares will go down as well as up, so you may get back less than you invested.

    However, a glance under the surface shows that things are not quite as straightforward as the headline numbers would suggest.

    Looking under the bonnet

    It is worth noting that much of the growth in dividend payments in Q2 was fuelled by special dividends and the weakness of the pound.

    Several significant dividend-paying stocks set dividends in currencies other than sterling. This includes HSBC and Shell, the top two dividend payers this quarter. The weaker pound means that even though Shell held its dividend flat in dollar terms, the sterling value of the first quarter dividend rose 12.6%. This source of dividend growth can easily reverse.

    Special dividends are also far from reliable. Although some companies do pay a special dividend regularly, most use it as a means of returning windfalls to investors. This quarter is no exception, and includes a £3.2bn special dividend from National Grid after it sold a 61% stake in its UK gas distribution business. That payment isn’t going to be repeated next year.

    However, even excluding the effects of currency and special dividends, ordinary dividend payments still grew 7.8% compared to a year previously. With inflation running at around 2.6%, that’s a substantial boost to real income.

    How sustainable are they?

    When investing for income, investors should always ask themselves ‘is this dividend sustainable?’. There are lots of different ways of judging that, but the simplest, rough and ready approach is to compare dividends per share with earnings per share – known as a dividend coverage ratio.

    Unfortunately, on this measure the recent surge in dividends leaves the UK market looking worryingly stretched.

    The graph below plots the change in the total earnings per share for the FTSE 100 over the last 10 years against the dividend per share. You can see that over the last 3-4 years growth in dividends has far outstripped earnings. In other words the dividend is taking up a larger proportion of company profits. That reduces companies’ ability to weather tough times while leaving the dividend intact.

    Percentage change in FTSE 100 earnings per share and dividend per share

    Dividends are variable and yields are not a reliable indicator of future income. Source: Bloomberg, 07/08/17

    What’s behind the earnings fall?

    Just because the market’s dividend coverage ratio has been declining, it certainly doesn’t follow that all dividend payments are now less sustainable. In fact, the divergence in earnings and dividends from late 2014 is largely a result of falling commodity prices.

    Oil giants Shell and BP are two of the biggest contributors to total dividends in the UK market – with Shell alone contributing 9% of market dividends. Neither company has cut its dividend, but lower oil prices mean earnings have fallen substantially, and dividends are significantly less well covered than they once were.

    This dramatic change in two such important stocks has undermined coverage ratios for the market as a whole. Underneath that there are plenty of stocks where the numbers still look healthy.

    Enviable track records

    The stock market includes several companies who have track records of dividend growth stretching back to the 1990s but which also maintain healthy coverage ratios. Two stand out particularly for us, plastic packaging manufacturer RPC and pub company Greene King.

    Both have records of consistent dividend growth stretching back to before the millennium, while also targeting sensible levels of dividend cover of 2.5 and 2 times respectively. Companies with these kinds of dividend track records will often find their yields compressed, but both continue to offer prospective yields of reasonable size, with RPC trading on 2.9% and Greene King on 4.8% (variable and not a reliable indicator of future income).

    Of course there are potential headwinds. RPC recently saw its shares fall significantly amidst fears that its acquisition-led growth strategy was masking a poor operating performance, while few companies are as exposed to the mixed outlook for the UK economy as Greene King.

    However, in the long run we feel that both companies remain attractive, and look well placed to maintain their impressive track records.

    Download our free guide: How to select shares

    The author holds shares in RPC.

    Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

    This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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