The sharp pullback in the value of sterling this year has had a big impact on the stock market landscape. On one hand, the outlook for some domestic stocks and sectors has turned much more uncertain. But for others with exposure to foreign markets and currencies, these conditions are a welcome boost. One of the immediate positive results for investors is that dividends rose strongly in the autumn. But you had to tread carefully to separate the winners and losers – and that’s likely to continue.
Dividend paying shares have been a popular target for investors in recent years. Faced with low interest rates and low bond yields, the average UK stock market yield of 3.5 – 4.0% (plus capital growth) has obvious appeal. But that popularity has stretched the valuations of some solid, blue chip income stocks, or ‘bond proxies’. It’s also the case that some traditional high yielding industries like mining and supermarkets have witnessed sharp payout cuts. So where are the most promising parts of the market for dividend hunters now?
How exchange rates impacted dividends
According to new figures, dividends from UK stocks rose by 1.6% to £24.9bn between August and October. Strip out the impact of special dividends, and the rise was 2.6% to £23.9bn. Research by Capita shows that there was a big £2.5bn currency gain during the quarter. That was caused by the large dollar- and euro-denominated dividends from the likes of Royal Dutch Shell, HSBC and Unilever being translated at much more favourable rates to sterling.
But under the surface, there were areas of concern. For a start, stocks in the mining sector – which has been very strong this year – were responsible for most of the £2.2bn of payout cuts during the autumn. And more generally, despite the overall rise in dividends, average payouts fell slightly in Q3 on the same period last year.
Sectors and indices leading the dividend charge
On a sector basis, the most immediate beneficiaries of a weaker pound have been oil amp; gas, beverages, pharmaceuticals, banks and mining. The main sources of dividend growth have been telecoms, media, travel and insurance.
On an index basis, almost all the dividend cuts seen in the third quarter were in the FTSE 100. But the same index had almost all the foreign currency gains.
By contrast, the FTSE 250 saw the fastest dividend growth. That was up 4.9% on the same period last year, at £2.7bn. Strip out special dividends, and the underlying growth was 11.5%. This is interesting because the mid-caps of the FTSE 250 tend to be more sensitive to uncertainty in the UK economy. The index certainly got a harder shake after the EU referendum. Yet, according to Capita, these stocks have been well insulated from the trends that have caused so much trouble in the FTSE 100 (such as low commodity and oil prices, and industry pressures in banking and supermarkets). As a result, mid-cap profits have outperformed, meaning that these companies are growing their dividends consistently faster.
With these trends in mind, I constructed a dividend screen looking for high forecast yields in the most promising sectors. Among the rules are:
Also included is our new pension deficit / market cap ratio to highlight any areas of possible future concern caused by ballooning pension deficits. Stockopedia members can can see the full screen here.
|Name||Forecast Yield %||Forecast Dividend Cover||DPS Growth %, Last Year||Piotroski F-Score||Pension Dfct / Mkt Cap %||Value Rank|
|Paragon of Companies||4.3||2.8||22.2||5||2.33||78|
On the surface, the screen picks out yields that are well above average, and dividends that are generally well covered by earnings. After last year’s big dividend hike, Lloyds Banking Group leads the list with a forecast yield of 6.4%.
There are none of the classic bond proxies here, which are generally found in the tobacco, household goods and beverages sectors. In many cases, the prices of stocks on the list have come under pressure since the summer. But valuations – based on the ValueRank – do vary, with the cheaper stocks notably in transport, such as Stagecoach, Go-Ahead and easyJet. It’s worth noting, though, that Stagecoach and BT have considerable pension deficits. That may not be a problem now, but low bond yields are causing concern when it comes to pensions deficits. So it could be worth keeping an eye on these figures in any kind of dividend screen.
Looking ahead, it’s likely that dividend shares will continue to hold the attention of investors. In our regular performance round-up of investment styles, income strategies have more than held their own this year. And while the devaluation of sterling has been a welcome boost in the FTSE 100, dividend growth among FTSE 250 companies is encouraging. An uncertain economic outlook is hardly good news for the market, but there are signs that the current conditions still offer interesting options for income investors.