Income has not been easy for investors to find during the pandemic. Bond yields remained stubbornly low despite rising inflation, while shareholders have seen dividend pay-outs vary wildly as countries and sectors plotted differing paths to recovery.
Thankfully, 2022 looks like being a better harvest. Rising interest rates have driven bond yields higher and dividends have also increased. In January IHS Markit forecast that shareholder pay-outs globally would grow 6% this year, led by the US (see chart).
This prediction was validated by the S&P 500 delivering over 30% earnings growth year-on-year, with three quarters of companies beating fourth quarter estimates. Meanwhile, strong performance from higher yielding sectors such as energy, industrials and mining also helped with many companies paying special dividends to boost income levels even further.
Uncertain future
So far so good, but while many corporates are currently awash with cash, the future is unclear. Even before events in Ukraine, earnings estimates for this year were cautious due to uncertainties over inflation, interest rates and energy prices. Russia's invasion now adds further doubt, particularly for companies impacted by sanctions and rising fuel costs, while the long-term economic impact of the conflict depends largely on whether, how and where it escalates.
In these turbulent times, when financial headlines are dominated by broad market moves, it is easy to lose sight of the important role that dividends play. Indeed, when share prices are falling they provide a valuable cushion for investors that usually results in lower stock volatility. Dividends are also a useful inflation hedge; by investing in companies that generate steady income and possess pricing power, portfolios receive similar protection.
Most studies show that dividends provide over 40% of shareholders' total returns so owning stable companies that pay regular dividends is a proven method for beating the market. They can determine success or failure for active investors and for those with long investment horizons like SKAGEN, their compounding effect can be particularly powerful.
Beyond purely financial benefits, a deeply-rooted dividend policy is also often a good indication of a company’s long-term health, strong corporate governance and management’s willingness to create shareholder value.
Income royalty
Like most successful investments, finding good dividend payers is easier said than done. While it is simple to select stocks with high dividend yields, this is often because they have fallen out of favour (the MSCI Brazil Index currently offers investors over 8%[1]) or have volatile earnings, such as commodity firms. Investing through a greener lens can also limit exposure to some of the best dividend-paying sectors – or increasingly rule them out completely in the case of industries like tobacco.
As value investors we typically look for companies with the ability (or potential) to translate competitive strengths into cashflows that are sufficiently positive to pay investors and fund business growth, ideally in a range of different environments. The benefit of this approach is that it can lead to stocks that don't have particularly high yields but are reliable dividend payers.
A good example is Nike, which yields less than the consumer goods sector average but has distributed dividends quarterly since 1985. The sportswear company recently extended its run of increasing pay-outs to 20 years, bringing it nearer to joining the Dividend Aristocrats; S&P 500 companies that have raised annual dividends consecutively over 25 years.
Alongside consumer goods, healthcare is another sector that traditionally pays generous dividends. Abbott Laboratories has declared 393 consecutive quarterly dividends since 1924 and this year progressed from aristocracy to become a Dividend King – an elite group of 38 US stocks that have increased pay-outs annually for 50 years.
Dividends in SKAGEN
Although many of our holdings pay regular dividends, SKAGEN's funds do not pay them out to unitholders. Instead, the income we receive from portfolio companies is reinvested in the funds, either in the same company or different holdings, depending on the opportunity set at the time. This flexibility means that clients benefit from the power of dividend compounding while ensuring that the income is also used to maximise unitholder value.
References:
[1] Source: MSCI Brazil Index, as at 28/02/2022