Beware of dividend traps in the rush for large cap safety

Thursday, Jul 07 2016 by
Beware of dividend traps in the rush for large cap safety

The vote to leave the European Union has left investors facing huge uncertainty. But one clear trend in all this confusion has been the strength of large-cap stocks with broad international exposure. Big, well financed companies that are cushioned from domestic economic gloom are precisely the types of equities that you might expect to do well in this environment. But not all large-caps are bulletproof, and general worries about possible dividend cuts mean that it’s worth treading carefully in the search for safety.

A shift in focus

A quick scan of Stockopedia’s 52 Week High Momentum screen (sorted by market cap) gives some clear signs about the types of shares that have pushed ahead in the wake of the EU vote. Consumer defensives, healthcare and utilities have generally done well. And given their strong flows of foreign earnings, mining and energy stocks have also jumped.

These sectors are home to some of the biggest companies listed in London, from Unilever and BP to Glaxo and Imperial Brands. They benefit from vast international exposure and may prove to be more profitable because of the weaker value of sterling.

This pattern is broadly repeated when you look at the 1-month relative price strength of shares across the FTSE 350. Those suffering most in the volatility have tended to be domestically-focused cyclicals, technology, construction and finance stocks.

To a degree this explains the strong rebound in the FTSE 100 since the EU referendum. Rather than signalling a bright outlook for the UK economy, it’s been boosted by a few defensive sectors - and companies with extensive foreign exposure - that have surged on the hope they’ll offer a safe haven in uncertain times.

Dividends under pressure?

Statistically, larger companies don’t offer the sort of explosive earnings growth prospects as smaller stocks. But many make up for it with the comfort of strong, sustainable dividends. One fly in the ointment however, is evidence that dividends are actually coming under pressure. One of the early warning signs is that dividend cover - a key measure of sustainability - is falling across the board.

Dividend cover measures how much of a company’s earnings are paid out in dividends. A ‘safe’ level of dividend cover is debatable, and larger companies do tend to pay…

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As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested. ?>

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6 Comments on this Article show/hide all

rhomboid1 7th Jul '16 1 of 6

Interesting article but I'm not sure you're interpreting the data correctly. Specifically Royal Dutch Shell (LON:RDSB) has publically committed to holding the dividend , it's also paid in USD so is likely to be on an increasing trend when converted to GBP. They have also ...hopefully...passed the nadir of the oil price decline and are now reaping the benefit of the LNG heavy BG acquisition.

I'm biased as Royal Dutch Shell (LON:RDSB) is my biggest holding but it is a good illustration of why macroeconomic backdrop can & should be referenced as well as the excellent stockopedia data.

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Rob Davies 8th Jul '16 2 of 6

Earnings data for most corporates is very flakey as the constant use of "adjusted" eps evidences. For that reason calculations on dividend cover should also be treated with caution.

Fund Management: VT Smart Dividend UK Fund
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williamhargrove 8th Jul '16 3 of 6

I would also concentrate more on Free Cash Flow cover rather than earnings cover. Dividends are paid from cash, not earnings.

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Whitbyview 8th Jul '16 4 of 6

In reply to post #141746

I think the whole UK is allowed to be biased on this one since Royal Dutch Shell (LON:RDSB) is supporting just about every pension and income fund there is. A lot of store is put on the fact they haven't decreased the divi since WW2 ... if they have to renege on this, metaphorically, it'll be time to find a tin hat again.

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Flackwell 8th Jul '16 5 of 6

In reply to post #141776

but the counter to that is it is the Real EPS that funds the dividend into the future - the amounts removed to get to the adjusted figure can't be ignored no matter how much the Board wants you to do that

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Alex1812 9th Jul '16 6 of 6

I am novice in this regard but I do like stocks that has a dividend growth policy year on year for a few years.More importantly selling /manufacturing products that we all need.Any ideas

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