UK companies - are they still giving in to “income bullies”?

I’m reliably told there once hung a poster in the CEO’s office at the London Stock Exchange which illustrated how the stock market worked in the 1950s. It featured a picture of a fictional Mr and Mrs Jones handing over their savings to a stockbroker who invested them in a company. It then depicted how the company was able to increase production and earnings and reward the Joneses with a rising stream of dividends.

What happened next? The arrival of the “income bullies”. This led to many companies opting to hand back too much cash to investors as dividends today, at the expense of balance sheet strength, or reinvesting more to grow the business and pay more dividends in the future. It’s fair to say UK quoted companies have been too quick to cede to such pressure many times in the past. But is this still a fair criticism?

We don’t think so, and we’re encouraged by signs that the UK stock market appears to be rediscovering its primary role as a source of funding for productive growth. Corporate and market behaviours have changed since the pandemic – the income bullies are in retreat, while investors who are more interested in sustainable dividend growth are getting a better hearing.

Certainly we’ve always believed shareholder returns should not come at any cost. That’s why we supported certain companies pausing dividends during Covid to allow them to focus on survival.

For the same reasons, we’re not blindly pushing companies to restore dividends to pre-pandemic levels. Instead we’re celebrating improved dividend cover – the ratio of earnings to dividends – which is back above two for the first time in a decade (see chart, above).

It seems the data is telling us that companies are no longer stretching to pay high dividends to the exclusion of investment for the future. And we’re very open to the possibilities created by this new set of circumstances.

If we think extra investment will be productive, we’re very happy to exchange dividend growth today for dividend growth in the future as companies realise higher rates of return on their investment. Examples here include BT, which is rolling out a nationwide ultra-fast fibre network, or Shell and energy business SSE which are both investing more in renewable energy.

BT is certainly going into fibre with its eyes wide open having negotiated the necessary regulatory pre-conditions to achieve a reasonable rate of return on this important new service for the UK’s digital economy. Meanwhile, we expect to see good opportunities in renewable energy, and believe the large integrated groups – whether that be SSE backed up by its networks, or Shell redeploying cashflows from its oil and gas operations – are well placed to capitalise on these, provided that risk adjusted returns are attractive.

More shareholders are seeing the bigger picture now, we feel. SSE’s proposal in 2021 to part fund a doubling down on investment into renewables with a dividend cut initially received a very frosty reception from some shareholders.

Judging by the positive share price performance since that announcement, however, investors are now willing to give the company the extra financial space to invest. Certainly SSE has a great long-term track record of delivering superior investment returns for shareholders (see: "30-baggers": why the UK has more than its fair share)

Companies and investors seem to have moved on from the dividend reinvestment debate, the bullies are in retreat and the criticism around distributing dividends should fade away too.