- Shares still diversify long-run inflation risk
- Steady dividend growers remain desirable.
When UK gilt yields are in the 4.5 to 5 per cent range along the yield curve, and (subject to restrictions and size limits) cash accounts are attractive, it begs the question: ‘why go hunting for income from riskier assets like shares?’ The income investor needs to think about when rates begin to fall, however. Having reliable dividend-payers as part of a multi-asset portfolio improves the chance of income generated growing ahead of inflation for the long term.
We place fewer restrictions on our UK large-cap dividend screen because its purpose is to give an overview of the situation for UK plc and the pay-outs and volatility investors should expect. The screen results aren’t to be thought of as ready made portfolios because passing the most tests doesn’t mean companies will be the best and most reliable dividend-payers going forward. The way to interpret the large-cap screen is by considering the tests that were failed and what questions that should lead you to ask next.
For example, although drinks bottler and distributor Coca-Cola HBC (CCH), which mostly operates in Eastern Europe and Africa, tops the screen for tests passed, the expected dividends on next 12 months’ basis only yield around 3.8 per cent on the current share price. Strong earnings growth is predicted this year, but historically the weaker dividend cover (it failed our dividend cover test based on the last full year), is cause to question how the pay-out will be able to continue rising when, as expected, earnings growth moderates in the following year.
Companies which have been quick to cut dividends in the past are flagged but not excluded from our large-cap screen. The Covid-19 pandemic means that this important flag only goes back two years, but shows that companies such as BT (BT.A), which is also forecast to deliver weaker year-on-year earnings this full year (and only slight growth the following year), and consumer goods giant Unilever (ULVR), which is undergoing big change, can choose to prioritise other uses of cash.
We do make the two-year dividend cut test compulsory for mid-cap and small-cap stocks. This is because here the prime driver in our company research is in finding the companies that can either join or eventually displace today’s large caps in providing the backbone of a dividend stream for an income portfolio. Screens inevitably flag some chaff but we can also flag companies with growing earnings and a propensity to return some of that to shareholders. Cyclical value traps are a danger with these screens, however, especially where smaller and mid-sized companies are concerned. Building products and brick manufacturer Ibstock (IBST) falls into that category. The company’s recent trading update was robust despite a tough macro backdrop, showing signs of quality for a future recovery, but analysts expect a dip in the dividends per share paid next year.
