Income Investing | Investing For Dividends - Is It A Busted Flush?

26th Mar '20 by Silver Moon

18 comments 992 reads

In 2019 I spent a lot of time diversifying from Large Caps with large dividends after get fingers burned with a company failure or two This year sees a strong risk of failure in the Small Caps I migrated to, and my old Large and Mid Caps are cancelling their dividends like there is no tomorrow. I wonder how this will affect the pensions and investment funds, are they between a rock and a hard place?

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About the Author

Silver Moon

Premium Member

Male, born in 1944. A saver who abandoned high interest cash accounts for equities when the bottom fell out of the interest rate. My mother's investment plan was to turn over the silver coins in her purse at the full moon, hence my moniker. more »

18 comments

stressor

26th Mar '20

As I mentioned last week, dividend cuts should only happen proportionately and in line with other cost savings measures (https://www.stockopedia.com/co...).....however this is not the case, and share holders are expected to carry most of the burden of company stress. For the record here is a list of dividend cuts from the FT today (and these are cancellation after announcement, and even after the ex-date):

Dividend cuts (£millions)

25-Mar-20 McBride 1.5
25-Mar-20 Morgan Sindall 17.3
25-Mar-20 Michelmersh Brick 1.1
25-Mar-20 Wilmington 3.7
25-Mar-20 Unite 120.5
25-Mar-20 Volution 3.4
25-Mar-20 Halfords 24.7
25-Mar-20 SSP Group 26.8
25-Mar-20 DFS Furniture 7.9
25-Mar-20 Vitec 12.2
25-Mar-20 Persimmon 751.8
25-Mar-20 Mears 10.7
25-Mar-20 Biffa 13.4
25-Mar-20 Walker Greenbank 1.4
25-Mar-20 Animalcare 1.4
25-Mar-20 Cairn Homes 19.3
25-Mar-20 Ibstock 26.8
24-Mar-20 James Cropper 1.1
24-Mar-20 Forterra 14.8
24-Mar-20 Whitbread 90.1
24-Mar-20 Grafton 29.7
24-Mar-20 Abbey 1.9
24-Mar-20 Shaftesbury 27.7
24-Mar-20 Cambria Autos 0.3
24-Mar-20 Bellway 64.1
24-Mar-20 Vertu Motors 4.1
24-Mar-20 Taylor Wimpey 485.7
24-Mar-20 Redrow 37.0
24-Mar-20 Secure Trust Bank 12.4
24-Mar-20 RPS 4.5
24-Mar-20 Gately 3.4
24-Mar-20 Learning Technologies 3.3
24-Mar-20 Zotefoams 2.1
24-Mar-20 Springfield Properties 1.4
24-Mar-20 Applegreen 1.0
24-Mar-20 K3 BusinessTech 0.8
23-Mar-20 Marshall Motors 4.5
23-Mar-20 Lookers 6.1
23-Mar-20 Filta 0.3
23-Mar-20 Synectics 0.6
23-Mar-20 The Works 1.5
23-Mar-20 ITV 216.2
23-Mar-20 Kingfisher 158.0
23-Mar-20 Aggreko 46.5
23-Mar-20 IWG 41.8
23-Mar-20 Stagecoach 22.3
23-Mar-20 Card Factory (2nd) 21.9
23-Mar-20 Go-Ahead 13.0
23-Mar-20 N Brown 12.0
23-Mar-20 Colefax 0.3
23-Mar-20 Bonhill 0.3
20-Mar-20 Marks & Spencer 132.6
20-Mar-20 InterContinental Hotels 120.4
20-Mar-20 Travis Perkins 83.2
20-Mar-20 Johnson Service 8.7
20-Mar-20 JD Wetherspoon 4.2
19-Mar-20 Crest Nicholson 56.0
19-Mar-20 Playtech 33.9
19-Mar-20 Elementis 26.0
19-Mar-20 NewRiver Reit 16.5
19-Mar-20 PPHE Hotel 8.5
19-Mar-20 Portmieirion 3.1
19-Mar-20 Gym Group 1.6
19-Mar-20 Shepherd Neame 0.9
18-Mar-20 MicroFocus 165.1
18-Mar-20 McCarthy &Stone 18.8
18-Mar-20 Marston's 17.8
18-Mar-20 Restaurant Group 12.4
16-Mar-20 William Hill 46.7
16-Mar-20 Shoe Zone 4.0
11-Mar-20 Costain 12.3
11-Mar-20 Dignity 12.2
10-Mar-20 John Menzies 12.2
26-Feb-20 McColl's Retail 0.7
25-Feb-20 Hammerson 91.2

also before the crisis:

12-Feb-20 INTU 62.3
30-Jan-20 Renishaw 5.1
09-Jan-20 Card Factory 17.1

TOTAL 3347.9

rpannell

26th Mar '20

It dosn't specifically answer your question, but large dividend paying Large Caps have not done well over the past 10 years. Compare these 2 ETFs - ISF (ftse100) and IUKD (top dividend payers ). The bottom graph is the IUKD

videoman

26th Mar '20

Just had my dividend payout today in my bank account from BP and I can see many companies not paying a dividend for the foreseeable future until the markets get back to some sort of normality.

jjis

26th Mar '20

Maybe in the short term as these are pretty exceptional circumstances & Companies are suspending dividend given their inability to forecast beyond this at the moment. The downside to dividends is therefore probably greater than that seen in the GFC in 2009 given this. In addition the broader indices in the UK at least are not helped by the concentration of dividends paid by big vulnerable sectors like Oil, Miners and Banks. See Dividend Monitor report from Link Asset Services here.

Beyond that you might expect dividends to bounce back once the resulting recession is out of the way, but this may depend in some cases on how the re-financing / bail outs are done. There has been talk that Companies that do get bailed out should be precluded from paying dividends & doing Share buy backs until it is repaid perhaps. SO the future MAY look different and your headline could therefore be right and as they say in investment, past performance is no guide to the future.

As ever I would say coming out of this, it will be even more important to assess the underlying quality of the business and the financial strength / resources they have which you will be relying on to deliver those dividends.

Regards, stay safe, stay at home, protect the NHS & save lives.

Jamie - Compounding Quality Growing Dividends (until this year!)

Website: Compound Income

Twitter: Jamie@Compoundincome

john652

26th Mar '20

I held the the dividend aristocrats ETF, they have been smashed worse than the fuse. What I'm not clear on is how these ETF's will deal with mass cancellations of dividends. ... And often, in normal ties a dividend cut is reflected with an increase in share price, I can see the opposite just as likely now.

Silver Moon

28th Mar '20

Jamie, your reply is appreciated, thank you. What bothers me most is the knee-jerk action by companies dumping dividends at this time, after all, those dividends are profits already made. I can't see any directors putting their hands in their pockets to return their bonuses and salary increases, can you? Stressor's reply has my thanks too for all the effort put into it, it reveals the number of abdications reach further than my concerns ever envisaged. For myself, this financial crash is a baptism of fire.

Silver Moon

28th Mar '20

I don't know about anybody else but the information you supplied is difficult for me to get my head round. I guess that when I get to re-balance my portfolios there will be less emphasis on Quality and more on Value. In the meantime I will ride this crash out.

Stay safe and don't catch Covid-19

William

Sharechap

28th Mar '20

I've just published a piece on this at sharechap.com My very personal view is that defensives should start to trade at a premium.

Rusty2

28th Mar '20

That is partly true I think, but if companies don't keep money in reserve to get through the though times ahead, then they may go out of business. Companies with cash and not high debts are in a much stronger position. Bonuses are often based on performance and profits so yes they can be cut, also when times are hard salaries can be cut also.

I think you should be looking at companies with strong balance sheets are low debt. Debt is not usually a problem when companies are doing well but in a recession it's a different matter. If they have spare cash they can also buy up competing companies.

timarr

28th Mar '20

What bothers me most is the knee-jerk action by companies dumping dividends at this time, after all, those dividends are profits already made

I don't think it's a knee-jerk reaction - if you're a director of a company that is effectively unable to trade you have a duty to ensure that the company is a going concern. As no businesses can run without any cashflow it makes absolute sense to suspend dividends until they can get some visibility: it's the fastest way of conserving cash. Businesses shouldn't cut jobs unless they have to as this will damage them in the recovery - hopefully in the short-term. If the pain goes on for longer then job losses are sadly inevitable.

Where companies need to raise money they normally do so in one of two ways - either by taking on loans or by tapping shareholders for cash via a rights issue. At the moment most debt finance paths are closed so the only alternative is to ask shareholders to stump up, probably at heavily discounted prices. Far better to conserve cash and wait and see what happens. In the worst case you would see companies paying out dividends, running out of cash, unable to raise new money and going bust. I'd rather lose a few dividends than my whole capital.

But in the end shareholders have no protection - that's why investing in shares is often very profitable, it's because we're taking on all of the risk. However, it often seems to me that shareholders don't realise this and have some fantasy that they're special. We're not - we're the owners of these companies and the buck stops with us.

I'd note that some directors have, quite rightly, taken pay cuts. While this is admirable, in most cases the savings are negligible in the context of the value of the dividends being lost. It's a gesture of solidarity with shareholders and workers, nothing more.

On a general point I'd expect any companies accepting government bailout money (as opposed to the general business support like business rates relief) to be banned from buybacks or dividends until it's repaid. Quite right, too.

timarr

Gromley

28th Mar '20

I agree, it seems entirely prudent to be cancelling dividends at this stage to preserve funds. Nobody knows how long the "lockdowns" will go on for, nor how quickly industries can pick up as restrictions are lifted.

By preserving funds at this stage companies are increasing the likelihood that they will be around to pay out dividends in the future.

Mind you, I have an unusual take on dividends. Dividend investors celebrate the 'generosity' of their companies who give them free money on a regular basis.

Instead I see it as them distributing your share of the cash on the balance sheet to you. Before the dividend is paid, you have a share of the companies cash balance, after the event you have some cash in your personal account, but your share of cash on the company balance sheet is reduced by the same amount. (Hence why share prices fall on XD date).

That is not to say that I eschew dividend payers. To me though the benefit is somewhat different. Dividend payers are proud of their dividends and recognise the pressure from investors not to reduce them. So if a dividend payer increases their dividend, they are not just telling you that they have had a good year, but also crucially that they have confidence in the future, such that they can sustain or increase the dividend in the future.

Of course the counter to that is that if a reliable dividend payer does cut, then you really should sit up and take notice.

However, dividend history might imho still be a decent indicator in the current market. These businesses tend to be intrinsically less risky and their ability to preserve funds in this way potentially gives them more scope to survive through this period of external threat.

jwebster

28th Mar '20

The problem with high yield dividend companies is they are really bond proxies but with no recourse, like a corporate bond. And they have no terminal value date, such when they are supposed to return your capital to you. For that, you have to rely on their share price holding up indefinitely, with all the attendant risks.

Companies with high dividends are usually ex-growth. Rather than reinvesting profits into the business they distribute them as dividends. Compare Shell with its high dividend with Amazon which reinvests all profits.

I realise high dividends are popular for income but wouldn't you be better off owning a growth stock and selling a small number of shares each year for income, paying lower capital gains tax than dividend income tax ?

Warren Buffett writes about this. He looks at earnings yield as a % of market cap and ROE. He likes companies with high ROE who reinvest profits and thus grow. Amazon has an ROE over 20% and so reinvestment of earnings is compounding nicely, for now at least. Buffett's largest holding, Apple, has an ROE over 50%. He actually publishes a table which shows his holdings dividend % plus their retained earnings as a % of market cap, as he see the two together as the true 'yield'.

Just a thought!

timarr

28th Mar '20

Hi Gromley

I agree. A company makes profits and either distributes them to shareholders as dividends or reinvests them in order to grow future earnings. It's a question of capital allocation - can the managers of a company reinvest those earnings better than I can?

Many people prefer the security of a dividend in the hand over leaving it with company managements but if I get the cash and reinvest it then I have to make another decision - which, from personal experience, usually turns out to be a 50/50 toss of the coin. Any company I retain a shareholding in for a lengthy period of time is usually a decent investment (otherwise I'd get rid of it), so all things being equal I'd prefer my companies to retain earnings and reinvest them rather than returning them to me.

If I need a "dividend" I can sell something - and as I have 100% of my shareholdings in tax shelters that has no side effects on my wealth, but obviously that's not true for everyone. But still, the tax tail shouldn't wag the investment dog.

The flip side of this - which I often hear - is that investors don't really trust managements to do the right thing with their capital. Frankly that's an odd argument - if you don't trust the management you shouldn't invest in the company and, in any case, the dividends we get are (usually) dwarfed by the capital value of our investments. If a company's managers are incompetent or worse we have a lot more to worry about than the odd dividend.

By and large I ignore dividends in investment decisions other than as a sanity cross-check - a large dividend is usually a sign of a) something wrong or b) a lack of growth - but not always. And I'm well aware that high dividend yield strategies can lead to extremely good returns if you put other quality checks in place.

Looking at the initial raft of dividend cutters - there are many more to come - it's generally a pretty motley bunch. There are some good companies, particularly in the housebuilders and pub chains, but otherwise it's a frankly uninspiring bunch. Ssp (LON:SSPG) is a very fine company and I'm looking at it hard, I already own Redrow (LON:RDW) and Young & Co's Brewery (LON:YNGN) (not on the list but also confirmed as suspending the dividend), Persimmon (LON:PSN), Portmeirion (LON:PMP) and J D Wetherspoon (LON:JDW) look like the pick of the bunch. Bar the latter, whose management doesn't meet my criteria, they're all of interest.

Many companies will retain their dividends but I don't think doing so is always a sign of strength. Given that there will be corporate casualties everywhere retaining cash and deploying it to pick up distressed competitors would be my preferred strategy - but once the dust settles I imagine there'll be plenty of cheap loans available to financially secure companies, so it's probably a moot point.

But basically - investing purely on the basis of dividends is to misunderstand the nature of being a shareholder. At least that's my view, although doubtless others will disagree.

timarr

HumourMe

29th Mar '20

Any company I retain a shareholding in for a lengthy period of time is usually a decent investment (otherwise I'd get rid of it), so all things being equal I'd prefer my companies to retain earnings and reinvest them rather than returning them to me.

I agree with everything you wrote but wanted to use this as a jumping off point for my own thoughts.

This assumes that over the long term, share price appreciation will reflect the intrinsic value of retained earnings reinvestment. I happen to believe this is true typically, however, also believe that for individual shares, there is a large random fluctuation around fair value that can persist for years.

If comparing two companies, one with a high return on X and another with a high dividend then the high dividend payer may give a higher probability of return.

Of course dividend investing relies on the probability of actually getting the payout, which itself relies on its own set of assumptions.

This crisis has exposed that any future return model is exposed to unknown factors. If you pay too much for 'return on X' you decrease the probability of being able to cash in. On the other hand if you chase extreme or covered dividends, you are implicitly assessing that most other people who do this have assessed the future return incorrectly. To be fair, any purchase probably makes this assumption.

To return to the article headline I believe that at the moment almost all models are broken, due to a huge information gap, that will take time to work through. I've no doubt that there is the opportunity for the skilled/lucky to make some great purchases. It just feels too risky to me and will probably do so until the volatility settles down.

timarr

29th Mar '20

To return to the article headline I believe that at the moment almost all models are broken, due to a huge information gap, that will take time to work through.

Agreed, but any model that uses historical information to predict future performance - which is to say all of them - is fundamentally flawed. As Taleb says, it's picking up pennies in front of the streamroller. On a reasonably regular basis we see huge market discontinuities caused by things that the models can't possibly predict and then everyone throws their hands in the air and says it's just one of those things that they couldn't do anything about.

Well, it's not. It's situation normal and institutions or investors that have been exposed to the full force of the downturn should be looking hard at themselves and not blaming external factors. One perfectly reasonable response is to do nothing if you've invested in the right sort of things - I can't imagine Nick Train is ditching anything in the Lindsell Train funds that he doesn't have to to fund redemptions. But the point is that this type of thing happens with disconcerting regularity and if you didn't have a plan you really need to think about why not.

In terms of overpaying for return there was some excellent research done by Rob Arnott a few years ago showing that people consistently identify growth stocks but then overpay for them, thus losing the benefit. As now we have growth stocks on sale it's probably a good time to start looking hard and doing some real thinking about what will return to growth when the crisis has passed, as opposed to relying on broken models.

Of course, in a couple of years the models will start to work again and people will start picking up pennies again. Hopefully, next time they'll be more aware of the steamroller chugging away in the background ...

timarr

HumourMe

29th Mar '20

In terms of overpaying for return there was some excellent research done by Rob Arnott a few years ago showing that people consistently identify growth stocks but then overpay for them, thus losing the benefit. As now we have growth stocks on sale it's probably a good time to start looking hard and doing some real thinking about what will return to growth when the crisis has passed, as opposed to relying on broken models.

Both William O'Neil (CANSLIM) and Minervini as archetypes of the techno-fundamentalist growth approach say that the major gains are made in the first couple of years after a bear market. So this is exactly what I'm trying to prepare for.

CANSLIM (paperback 4th edition p223): The really big money is usually made in the first one or two years of a normal new bull market cycle. It is during this period that you must always recognise, and fully capitalize upon, the golden opportunities presented.

The same conclusion is echoed by Minervini

Trade like a Stock Market Wizard (p167): The stocks that hold up best and rally into new high ground, off the market low during the first 4 to 8 weeks of a new bull market are the true market leaders, capable of advancing significantly. You can't afford to ignore these golden opportunities.

Looks like I need to re-read Taleb when I've finished those.

Of course, in a couple of years the models will start to work again and people will start picking up pennies again. Hopefully, next time they'll be more aware of the steamroller chugging away in the background ...

Some will have learnt and will get the hell out of the way. Some of the new generation though, will argue that this time is different.

timarr

30th Mar '20

The stocks that hold up best and rally into new high ground, off the market low during the first 4 to 8 weeks of a new bull market are the true market leaders, capable of advancing significantly. You can't afford to ignore these golden opportunities.

Well ... firstly, this is all empirical stuff, there's no guarantee it'll hold going forward. In the wake of the 73/74 crash the UK market recovered 50% in 8 days. Most people and institutions were in cash and missed it.

Secondly, psychologically if you spend (say) a year sitting in cash feeling relieved and watching the world fall apart the it becomes incredibly difficult to deploy that safety net at speed. There's always the nagging doubt that it'll all fall apart again.

Finally, Minervini and co are all rich already. It's very easy to present this kind of model when you're really not risking your future on it. Most of us aren't in that fortunate position.

But everyone has to find their own way through this minefield. Raft of more dividend suspensions today, income seekers are going to find it tough going forward. Not that everyone else won't as well of course.

timarr

jonesj

30th Mar '20

Even when I get a dividend, it's usually paid within my ISA or SIPP and remains in the ISA or SIPP.

When I need cash for living expenses, I just sell something from the taxed portfolio.

I try to view dividends as just another component of shareholder return.

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Investing for Dividends - Is it a Busted Flush?

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Silver Moon

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