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Lower dividends may become the new normal

Effects of COVID-19 mean the future for dividends is uncertain.

Decreasing stack of coins next to a jar labelled "dividend"

by
John Redwood

in Features

01.04.2020

Yesterday we raised the likelihood of bank dividends being cancelled in the light of the attitude of the ECB. The European and UK commercial banks have now confirmed they will not be paying dividends during the virus crisis, nor buying back any of their own shares. Under strong guidance from the Central bank regulators, they decided they need to conserve cash. They wish to be able to absorb more losses on loans they have already advanced and to have more capacity to lend to the many businesses and individuals who are now short of money.

Despite this important move which expands their ability to lend significantly, there are problems for many companies in accessing credit in a timely and affordable way to see themselves through a period of little or no turnover. Banks still expect up to date trading accounts, balance sheet statements, cashflow forecasts and business plans when businesses have little or no forward visibility on when and how much they can trade. Banks are also still asking for pledged assets or personal guarantees from shareholders and directors. Businesses are pointing out they cannot forecast sensibly as they have no idea when they can resume something like normal trading in the various countries that have all imposed strong restrictions on their activity. In practice, the companies want something more like a grant or interest free borrowing, whilst the lenders want a profitable loan that is unlikely to go wrong.

We have stressed throughout this crisis that cash is king. Companies with no turnover need cash desperately and have to rein in expenditures rapidly to ensure survival. Removing dividends and stopping share buy backs are the easy things to do before boards go on to the much more difficult issues of staff costs, stock levels and property commitments.

One of the big arguments used to sustain high and rising share prices before the market crash was the high level of dividend yield. The last decade saw the disappearance of the reverse yield gap of the inflationary era where high grade bonds offered a higher income than the average share. It was replaced by a yield gap, with a growing advantage of dividend levels over the interest on high quality bonds. This great strength of shares has at least for the short term ended for all those companies that will not pay a dividend. Today the question before a board is not how do we ensure we can pay the dividend but is there a good reason why we should buck the trend and pay one.

The attitude towards dividends is in part being altered by the sense of national endeavour in many countries where leaders are defining the fight against the virus as one where all have to make sacrifices. It is also being transformed by the need of many individual companies to survive by husbanding their cash. The minority of companies that are trading well in these worrying circumstances, like the food retailers, some medical suppliers and some providers of online services, will have difficult judgements to make. Do they pay out higher dividends as they will be able to do, or do they restrain themselves for fear of appearing to profit too much from the general adversity?

Income investing both through Income funds and discretionary portfolios is now very difficult in the short term. Some large companies paying big dividends may draw on reserves and balance sheet strength to maintain payments, but many companies will put cash preservation and the current mood first. Income funds may experience more sales and redemptions as disappointed investors look elsewhere. In a world where the income return on shares might typically be half the total return over the longer term, a large reduction in dividends is unwelcome.

This brings us back to the only thing that really matters to markets. How long do the closures continue? Were they to be short-lived, we can look forward to an earlier and fuller bounce back. Then some dividends would prove to have been deferred, not lost, with others being restored the following year. The longer the closures last the more we need to regard lower dividends as part of the new normal, which also means lower share prices without the extra yield support. Yesterday on both sides of the Atlantic the news was for continued closures to drive new cases of the disease lower.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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