Although bond yields are higher than the dividend yields, they may not provide the same inflation mitigation as the stock market. However, investors need to ensure they’re in the right areas, says the BlackRock World Mining team.
For the first time in more than a decade, gilt yields are higher than the dividend yield for the FTSE All Share.1This creates a new landscape for dividend investors, one where there is real competition for investors’ capital between bonds and equities. What role can dividend paying equities play in this environment?
The first point to note is that while the yield on both UK government bonds and the UK stock market is relatively high, it is below the current level of inflation. A 10-year government bond currently has a yield of 4.3%,2 while the FTSE All Share index has an aggregate dividend yield of 3.7%.3 Inflation is running at 7.3%.4 This means investors who are only receiving the income are losing money in real terms.
Inflation is expected to drop, with the Bank of England saying that it will reach its 2% target by early 2025.5 However, there are no guarantees, as the past 12 months have shown. In the meantime, investors could see a short-term erosion of the purchasing power of their savings if they don’t take steps to protect themselves against inflation.
For conventional UK government bond investors, this is a problem. The income will not grow in line with inflation, and while the capital is repaid at the end of the term, it also has no protection from inflation. For investors in shares, the outlook is slightly different. Companies may be able to raise their prices to reflect inflationary pressures, which in turn can be passed on to their shareholders in rising dividends. The most recent Computershare Dividend Monitor, which measures dividends in the UK market, showed dividends growing at an underlying rate of 5.6% in the first quarter of 2023.6
However, this is not universal. Companies may have no pricing power, perhaps because they operate in a competitive industry, with low barriers to entry, or because they have a difficult period of trading performance. This will leave them unable to raise costs and their profitability – and therefore their ability to pay dividends – may weaken. Investors need to be focusing on those companies that have the power and inclination to raise dividends over time.
Finding dividend growth companies
A recent report from independent trust analyst Stifel found that there are currently 34 trusts investing primarily in equities with a dividend yield of 4.0% or higher.7 The BlackRock World Mining trust is one of those trusts, with a current yield of over 6.3%. We have built up a long-term track record of paying a high and rising dividend to investors. Our view is that there are certain crucial elements in finding companies likely to pay a rising dividend.
First, we want to see that a company is paying a dividend out of growing revenues, rather than jeopardising its financial security to pay cash to its shareholders. We see this at the moment with the mining sector, where companies have worked hard to strengthen their balance sheets and been prudent on borrowing. As commodity prices have risen, this has put them in a stronger position to pay dividends to shareholders.
Equally, we also need to ensure that a company is in a good position to grow its dividend over time. This means gravitating to those companies with the capacity to deliver stronger earnings growth over time. These are companies with a strong ‘moat’ for their business, a good market position and pricing power. If a company can’t grow its earnings, it can’t grow its dividend in the long-term.
As fund managers, we want to see that a management team has the inclination as well as the ability to pay a rising dividend over time. That means we like to see a compelling track record that shows the management team is committed to rewarding shareholders in this way. This is not a given. Some management teams have proved reluctant to distribute capital to shareholders.
We believe these qualities will be particularly important at a time when equity investors increasingly need to compete with bonds. Equities have the potential for long-term growth in dividends and capital, which should be a bulwark against inflation. However, it is not assured, and as investors, we need to pick with care.
1https://www.marketwatch.com/investing/bond/tmbmkgb-10y?countrycode=bx – Marketwatch U.K. 10 Year Gilt, 07/08/23
2https://www.marketwatch.com/investing/bond/tmbmkgb-10y?countrycode=bx – Marketwatch U.K. 10 Year Gilt, 07/08/23
3FTAL | SPDR FTSE UK All Share ETF Overview | MarketWatch- Marketwatch FTSE All Share, 07/08/23
4https://www.ons.gov.uk/economy/inflationandpriceindices Office for national statistics, Inflation and price indices, 07/08/23
5https://www.bankofengland.co.uk/monetary-policy-report/2023/may-2023#:~:text=An%20economy%20in%20which%20households,will%20stop%20increasing%20so%20quickly – Bank of England, Monetary Policy Report, 11/05/23
6https://www.computershare.com/uk/insights/share-register/dividend-monitor/q1-2023 - Computershare, UK Dividend Monitor, 31/03/23
7Stifel: ‘High Yielding Equity Trusts’ as at 19 July 2023
