Adrian Frost: Are UK Dividends Secure?

No question is more topical today than how sutainable the dividend yield on the market might be. If there is a case for holding equities, it rests on the impressive-looking yields that are currently available on a number of well-financed UK companies. These are the views of Adrian Frost, the highly regarded income fund manager at Artemis, as reported on the Hargreaves Lansdown website. (In the interests of full disclosure: I am a non-executive director and client of Hargreaves Lansdown).

“One thing is sure. 2009 will see more dividend cuts. We saw just short of 100 such cuts in the FTSE All-Share in 2008. More will follow. For the moment they are confined to banks and economically sensitive areas – but this may spread. Yet at the moment, despite the FTSE All-Share Index indicating a dividend for 2009 some 7% below last year (source:DKB), we believe that the dividend on prudent equity income funds will be flat at worst”.

“Looking ahead, the ‘big question’ is: are (enough) dividends sustainable? Consider five salient facts:

  • 37% of all dividends are paid in US$. So unless you think the dollar will die, these seem okay.
  • 25% of UK dividends come from oil companies. To us, BP, Shell and so on look cash-rich and healthy, and say that they could maintain dividends for a year even at $35/barrel.
  • The top 25 London-listed companies generate 74% of UK dividends.
  • The top eight companies – HSBC, BP, Shell, Vodafone, Glaxo, Astra, BAT and BT – generate 50% of UK dividends. We own them all, except (for very good reasons, in our view) BT.
  • “Four years ago, 43% of our fund was in FTSE 100 companies. That percentage is now 76%.

“Our fund’s yield is 6%*. Do we think that, without undue risk, we can maintain that? Yes. Our view is to hasten slowly in the months ahead. Stick to the basics, cash flow and dividend, and all should be (relatively) well”.

My comment: nobody can doubt that the first two months of the year have been brutal for the equity markets, but dividends are the key to long term equity returns. The recent LBS/Credit Suisse Global Investment Returns Yearbook showed that at the end of 2008 the long run capital return on equities since its authors’s data series began (in 1900) was less than half of one per cent, with all the return coming from reinvested dividends.

A 6% market yield, if it does indeed prove to be sustainable, has historically never failed to produce strong equity returns over five years – something to cling on to as the value of your equity portfolio is slashed further by the current wave of violent downward lurches in the leading indices.

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