Dividend cover fell in 2019 as sluggish profits and high payouts left companies with weakened balance sheets heading into the coronavirus pandemic.
Companies have subsequently slashed dividends to shore up balance sheets amid an uncertain global economy. Dividends are expected to fall between 15 and 34 per cent in 2020, according to research by asset manager Janus Henderson, and dividend cover for the year is uncertain, ranging between 1.9 to 2.5 times the annual global dividend.
The breadth of dividend cuts means that dividend cover, or the ratio of a company’s earnings to the dividend it pays shareholders, has so far remained strong. This is unusual in a recession when companies typically find themselves with thinning profits.
“Normally in a recession, companies would flex their dividend cover target and dividends would reduce much less than profits. So far, 2020 is proving to be different,” said Ben Lofthouse, fund manager of Henderson International Income Trust.
Globally, profits rose 1.1 per cent to £2.15tn last year, while dividend payouts leapt almost 9 per cent from the year before, hitting a record £1tn in payouts, Janus Henderson found.
However, profits are expected to fall by at least one-fifth in 2020, which will affect dividends in the coming year as companies try to protect their balance sheets.
Dividend cover could possibly fall as low as 1.9 times in 2020, down from 2.1 times in 2019 and 2.3 times in 2018, compared with a drop to 1.4 times in 2008. If dividends fall by the maximum expected amount, Henderson said that dividend cover could rise to 2.5 times in 2020.
Dividends are vital for investors looking for income from their investments and dividend cuts have an outsized impact on pensioners. However, investing for income can overexpose investors to a small number of companies paying out large dividends, though their sectors are in structural decline.
“High dividend payers have been crucified in recent weeks,” said James Norton, a senior investment planner at Vanguard UK. “This is why diversification and not just buying high dividend stocks is important.”
Though a company might opt to increase its dividend, a declining share price will still hurt investors’ capital. “If you are invested in a company generating high income, that may be at the expense of capital,” he said. “I think that a lot of investors don’t understand the additional risk they’re taking by seeking a higher income approach.”
Investors use the dividend cover ratio to measure the sustainability of payouts. The report by Henderson found that companies with half the average dividend cover are twice as likely to cancel their dividends, leaving investors without income. In 2019, one-fifth of UK dividends were paid by companies with poor dividend cover, or “dividend traps”, putting investor income at risk.
“High yields are certainly tempting, but they are dangerous,” said Mr Lofthouse, citing recent dividend cuts by traditional big payers such as Royal Dutch Shell. Though the oil and gas sector was one of the biggest drivers of this year’s dividend cuts, it had one of the lowest average dividend covers in 2019, far below the average at 1.5 times. Technology had the highest cover, at almost three times.
Investment trusts have proved to be popular with investors looking for guaranteed income rather than large payouts. These closed-ended funds are able to hold on to profits in good years in order to smooth payouts for investors in lean years. Some trusts have paid or increased their dividend every year for a decade.
Investors of advancing years who move away from active trading say trusts can be a reliable source of income requiring little management. Anthony Burkhardt, a 92-year-old pensioner and investment club member who spoke to the FT, said that while his income had taken a 40 per cent hit because of this year’s dividend cuts, he can meet his financial obligations in part because of income from investment trusts.
“Investment trusts have stood up to the storm better than individual companies,” he said.