Saw the Q4 Dividend Monitor Update from Link Asset Services yesterday. This confirmed previous projections that UK dividends were down last year by around 44% or 38% underlying if you exclude special dividends. More significantly they updated their best case scenario for dividends in 2021 in light of the latest lock down. Within the document which you can see a summary of and obtain from here they said:
Currently with FTSE trading at 6740 that leaves us pretty much in the middle of my suggested range. If however you are of a more bullish persuasion then if the FTSE 100 should trade down to or on the basis of a 3% yield then it might be possible for it to trade between 7800 and 8600 or thereabouts, but I wouldn't bet the house on that happening.
There you go steady as she goes on the dividend front but slightly depressing that dividends might not now bounce back as quickly as previously expected and that it might take until 2025 for the market to get back to where it was in 2019 in income yield terms. It is also worth noting that the Link report suggests that the UK market despite cuts from some of the larger paying stocks and sectors last year, still seems to be prone to concentration risk in terms of where the income is generated. Worth bearing in mind if you are investing in a UK tracker fund.
Personally I'd expect to get back to 2019 levels of income much sooner than that given that our portfolios avoided the worst of the dividend cuts by not being as exposed to concentration risk as the headline indices and thanks to our investment trust holdings. Mind how you go out there and in the market.
Having mentioned the dividend flows in the market and for the Compound Income Scores Portfolio in the September / Q3 update, I thought I'd provide an update having read the latest Link Asset Service Dividend monitor recently.
For the portfolio it looks like things are looking up on the dividend front this month with 9 holdings having gone or are due to go Ex Dividend, which is two times more than last year and the totals received are also over double. So as I said in the last update the large fall in year to date income, whilst no doubt reflecting the trends in the market, also reflects some stock and timing differences this year too.
As for the Link Asset Services I'll not try and regurgitate too much of the detail here but offer a few key takeaways and observations plus a link to the full document if you missed it and should wish to download a copy and read it for yourself. Below is their Executive summary with my thoughts thereafter.
Thoughts and Observations
Personally I find it somewhat surprising that Mid and Small Caps have cut more both in number and in quantum as these indices have gone onto outperform the FTSE. Then again perhaps I shouldn't be as Mid and Smaller Companies may be more vulnerable to effects of the virus / shut downs etc. and dividends are not really driving returns this year or any other year for that matter.
In terms of the outlook they seem to think we are through the worst of the battle on the dividend front as we have seen some Companies starting to reinstate or make up for missed dividends in some cases. As a result they see the underlying dividends falling by around 39% for the year and by about 45% if one includes specials. So this is not far off the 30 to 50% falls that were talked about earlier in the year.
While for next year they are expecting some modest bounce back in dividends and tentatively suggest growth of 6% to 15% on a worst case to best case scenario. On this basis they see the current prospective yield being between 3.3% and 3.6% which they suggest leaves UK Equities looking fair value.
Thinking about that and the Ready Reckoner I presented back in the Spring that would be at the bottom end of the yield range of roughly 3.5% to 4.5% that we have seen for FTSE in recent years. With dividend having been cut back to more sustainable(?) levels then may be it makes sense for the market to trade towards the bottom of the range on a yield basis, perhaps. This is especially so given the fall in interest rates, bond yields, property rents and talk of negative rates by the Bank of England.
For what it is worth I present an updated version of the FTSE Ready Reckoner with two new rows reflecting Links latest thinking versus my original 33% to 50% cuts estimates and the original 3.5% to 4.5% range. Thus far the market seems to have operated on the basis of a 30 to 40% cut priced off of 3.5% or 5800 - 6400 roughly speaking.
Summary & Conclusion
So hopefully the worst is over on the dividend front for the UK market with a fall of 40 to 45% or thereabouts in dividends still foreseen, although this may have been discounted if investors are prepared to price those dividends off of a 3.5% yield. If not or if dividends were to fall a bit more then a re-test of the March 5200-5,000 lows on FTSE still can't be ruled out.
Indeed that leaves it looking pretty bedraggled and war torn with the chart trending down below its moving averages. Not great, as we head towards BREXIT but hopefully some resolution or last minute deal there and better news on the Virus front if a Vaccine should become available in the not too distant future might help sentiment. Failing that it seems we are in for a long hard winter as greater lock downs seem to be creeping around the Country and spreading South and Eastwards from the North and Wales!
Having said that it is a market of Stocks and there are always opportunities out there for individual stock pickers as demonstrated by some who have still managed to show decent positive returns despite all the problems. in addition UK Equities look pretty unloved and a bit cheap in a global context. So I wouldn't get too bearish and in the long run quality dividend paying equities still seem like a decent way to find a growing yield with potential for capital gains in a low yield environment. If you need help finding these don't forget that's exactly the type of stocks the Compound Income Scores try to identify.
Failing that if you would rather go down the pooled fund route & go active then I'd still recommend Investment Trusts which benefit from their closed end structure, independent boards and the ability to gear which can help to enhance or detract from returns depending on market conditions. They also tend to have revenue reserves and the ability to pay dividends from Capital which can make their dividends more reliable.
Given the bombed out nature of UK Equities it might be worth investigating a few UK Funds like Law Debenture (LWDB) which has solid reserves and benefits from an operating subsidiary which helps fund a fair chunk of its dividend and trades at a 4 to 5% discount with an experienced management team from Janus Henderson and offers a 5% yield.
Or there are a couple on wider discounts of around 10% which are either under new management in the case of Edinburgh Investment Trust (EDIN) or about to be in the case of Temple Bar (TMPL). Of these Edinburgh has increased it dividend and has decent reserves while Temple Bar has had to cut and will use reserves to pay its suggested dividend. But both might be interesting as a source of decent income from diversified portfolios, although you'd have to satisfy yourself that you are happy with the portfolio strategy of their new mangers.
Any way I'll leave it there as this note has already taken me longer than I thought and ended up longer too. So I'll leave you with a picture of the dividend history and outlook to sum up as I continue play some of my old favourites in the Stock market and on Spotify too.
Towards the end of November last year I flagged up Residential Secure Income (RESI) in a post that you can see here if you missed it or can't remember it. It is basically a play on social housing and you get to buy in at a discount to NAV & it offers a decent yield of over 5% which looks reasonably well underpinned which is no bad thing is these days of dividend cuts and suspensions left right and centre.
Any way they put out a COVID-19 update today where they gave an update on the portfolio, financial position and dividend. All seems fine, so check that announcement out if this interests you.
I added to my holding in the 70's during the recent sell off after they announced they had been awarded Investment Partner status by Homes England. Investment Partner status with Homes England extends ReSI Housing's ability to access grant funding to include schemes outside of London and bring forward much needed additional Affordable Housing at national level. So sounds promising in terms of their ability to deliver more homes, given they probably can't issue shares at a discount. i also noted that 4 directors were buying shares around this time too which gave me some reassurance.
It has done a decent job for me as a boring defensive play (see chart below) outperforming by about 20% and looks like it should continue to deliver the dividend too, so two ticks there. I guess there could potentially be some falls in house prices, but given the nature of their properties and the discount I'm not too worried about that.
Finally below the chart see a decent presentation that they did last year which might give you a better understanding of the business if it is of interest to you.
Apologies for the lack of posts recently, have been following all the economic and political fall out from BREXIT but not been doing that much in the market. One thing I did come across recently though was an interesting presentation about the merits of dividend growth investing which as you know is something I believe in.
I attach the presentation at the end of this post and although it is mostly based on US data I believe the findings it highlights are relevant to overseas markets as shown in the graphic from the presentation below which looked at this. As you can see it suggests that focussing on those stocks that pay a growing dividend and avoiding those that pay no dividend is a good idea. Those that offer growing dividends seem to offer higher returns at lower risk which is ultimately what everyone should be aiming for.
Other interesting observations included a look at levels of dividend cover which is something else I also focus on in addition to dividend growth. This found that those with middling levels of cover or the inverse as they looked at payout ratios delivered the best returns. So in terms of payout ratios it was the 3rd and 4th Quintiles which did best while Quintiles 1 (lowest payout ratio) and Quintile 5 (highest payout ratio) did worst. Interesting that those with the lowest payouts did consistently badly - maybe this is to do with them being growth companies and retaining capital which subsequently got wasted perhaps?
While by taking a very long term view and looking at rolling 15 year returns for US stocks they also demonstrate that dividend paying and those that grow their dividends have outperformed 100% of the time, although maybe that is just data mining for marketing purposes? Having said that though I think focussing on this type of stock for the long run will serve you well & don't forget that is exactly the type of stock that the Compound Income Scores seeks to identify.
Finally I saw today that Institutional investors have recently raised cash to record levels and reduced their equity exposure which probably helps to explain some of the volatility we have seen this year. However looking at one final graphic from the presentation suggested that at the end of last year that equities were not that over valued based on dividend yields versus their 20 year history.
... I thought was an appropriate title for this piece as we saw the launch this week of a new film version of Dad's Army in which no doubt the latest incarnation of Corporal Jones will utter his famous catch phrase. So what's that got to do with investing I can hear you thinking. Well the don't panic phrase is a good one to try and remember when we are experiencing volatile markets such as those seen this January and since equity markets, with the benefit of hindsight, topped out last spring / summer.
Now some readers may be younger than me and indeed you may have only got interested in the stock market in recent years when it seemed like it only ever went up. While some will be older than me and have seen it all before no doubt. But it is worth remembering that equity markets only go up about 60% of the time and in a bear market which is defined as a 20% drop from a top, they can and do go down by 30% to 50% or more as we saw as recently as 2008/9. In extreme cases when certain markets are unwinding from bubble conditions they can and do usually fall by around 80% or more from the peak - think .com stocks back in the early 2000's for a recent example of that.
Having said all that investing in equities for the long term (10 to 20 years) has in the past delivered decent real (after inflation) returns in the region of 5 to 6% per annum which is always worth remembering, but whether you achieve these returns is largely dictated by the price or rating you pay at the outset. Swings in ratings both up and down help to drive secular bull and bear periods in markets which seem to have lasted on average around 17 to 18 years. It seems to me that having had a 17 year or so re-rating which peaked out in 2000 with the .com bubble, we have remained since then in a secular bear market as the FTSE has failed to make a decisive break into new high ground. This has not however precluded big swings a profitable period within that along the way, which is also in common with history. Any way if you want to read more about the theory of these long cycles I would recommend a book Stock Cycles by By Michael J. Alexander - as featured in my Resources list of recommended books and other useful things. Included on there is a link to Crestmont Research - which is really useful resource for swatting up on market ratings history and secular bull and bear markets.
Aside from that I read a good piece on AAII.com recently which included some useful thoughts on a more rational approach to portfolio valuation. This basically talks about thinking like an owner as Warren Buffet talks about and having in mind a fair PE rating for the stocks you own. It suggests you then compare the rating that Mr Market is putting on your stocks and decide whether that is under or over valued and act accordingly rather than being influenced by noisy share price movements along the way. Seem quite sensible to me and well worth a read if you have been panicking about recent price moves on stocks in your portfolio.
Now for me the other longer term thing I focus on, as you know, is the income you can get from the dividends and compounding those. In a similar way to the article above, by focussing on these and what you think might be a fair or minimum yield you would expect on your stocks, you can also take a longer term perspective. Indeed it is also noticeable that in the past, although no guarantees for the future, that dividends have tended to hold up a lot better than prices during bear markets. This was evidence most recently in the 2008/9 bear market and subsequently when the UK stock market fell by around 50% but according to data from Capita (see page 6 of report) total dividend payments only fell by 14.3% between 2008 and 2010. They have since 2010 gone onto rise by 49% which represents an exceptional rate of growth of 8.3% per annum over the five years since then. I say exceptional as in the long run real dividends have tended to grow by more like 1 to 2% in real terms and indeed if you look at all the data in the Capita report on page 6 and include their forecast of a small fall in dividends for this year then the growth rate over the whole 9 years is likely to be closer to 3.5% per annum which in real terms will be closer to the long run average.
On the subject of dividends and their volatility versus the market prices there was an interesting look at the history of this in the US at A wealth of common sense - called The Incredible growing dividend. Now while this was US based data it did help to highlight why I like to focus on growing dividends and compounding them over time. Further to that there was an update last year to research from the value house Brandes Institute called: Income as the Source of Long Term Returns. This looked at the importance of dividends in the long term, the dividend yield gap versus bonds and also the stability of dividends in the longer term. Indeed they found that the volatility of the dividend streams themselves was a very small fraction (under one-twentieth) of the volatility of stock price movements.
From this report I particularly liked the lessons from the following extracts:
The message in Exhibit 7 is clear: higher dividend-paying stocks delivered higher total returns. While this was partly due to the dividend return, it is also notable that on a price-only basis, the top three quintiles of dividend-paying stocks had higher price and total returns than quintiles 4 and 5, as well as the non-dividend-paying stocks.
We have stressed the long-term nature of this research. However, many investors still have concerns over short-term price volatility. Did a focus on higher yielding stocks cause exposure to extreme stock price fluctuations? Again, the answer from our research is “No.” In Exhibit 8, we look at volatility of both stock prices and dividends within the quintile universe. Volatility of stock price returns was lowest for the highest dividend yield stocks, and increased steadily as dividend yields declined. So investors in the top quintiles received both higher returns (Exhibit 7) and lower volatility (Exhibit 8). My emphasis on the last bit there as that is as close to investing Nirvana as you can get I would say. I would also highlight that they also observed:
We have long held that paying excessive attention to short-term price movements is a behavioural error that can lead investors to make bad investment decisions. The data in this research suggests that investors might do much better to focus on their portfolio’s income stream as it develops over time. Exhibit 8 shows that the volatility of that dividend income stream was a very small fraction (under one-twentieth) of the volatility of stock price movements. To the extent that volatility causes investors to worry, switching attention from price volatility to dividend volatility might ease that worry substantially.
Summary & Conclusion
So definitely worth focussing on the income and thinking long term to avoid worrying about short term market volatility and making behavioural errors as a result I would say. Having said that though in the short term it is worth bearing in mind the Capita forecasts and the suggestions of others that dividends are more vulnerable now as levels of cover in the UK have been run down to low levels, so I suspect the outlook for dividend growth from the market overall may not be as good going forward in the short term, but do try and think long term and don't panic.
This is especially obvious in the UK given the concentration in income from the top 5 stocks which represent 33% of the income while the top 15 represent over 50%. As the top 5 all have question marks over the sustainability of their dividends, this is worth bearing in mind if you are investing in tracker funds.
That's why I prefer to invest and seek out companies able to grow their dividends in a diversified fashion so my income is not dependant to a large extent on a handful of companies and should therefore give me a growing income stream to live off of and compound over the long term as hopefully I might have another 20 to 30 years on this planet if I'm lucky. Or as the Brandes Institute put it:
We believe this research illustrates that the industry acceptance of five years as a long-term investment horizon underestimates the potential of reinvesting and compounding income. By reinvesting the income contribution of investment returns, investors can leverage the power of compound interest. Investors should not let recent market experience distort their perspective, and particularly should avoid preconceptions that income is less important than capital gains in its contribution to total equity returns. Income has served as a significant component of returns, and the combination of reinvested income and capital appreciation historically has presented the best option for long-term investors to realize optimal returns.
Cheers have a great weekend, whatever you are up to. Finally to bring the post to a close and to bring it back full circle to the title - as it is the weekend and it has been a while since I inflicted any music on you - here's a song from a new band The Brothers Osbourne called - Stay a little longer which seems appropriate in the context of this post.