Think big - Why income-seekers must now take a view on commodities and financial stocks
You know how people often talk about somewhere being a market for so-called ‘stockpickers’ – that is, investors who have built a reputation for identifying winning businesses while most other companies are treading water? Well, here on The Value Perspective, we are becoming increasingly convinced the UK has become a market for dividend-pickers.
What has really caught our eye is not so much that there are some huge dividend yields to be found in the market at present – there usually will be somewhere – but how many of these dividends are now associated with the UK’s very largest companies. What is more, we are not just talking about historic dividend yields here.
Obviously those can be high as the market takes time to wake up to the fact that what a company paid out last year might not be paid out this time – Glencore’s historic yield of 24% would seem a case in point. There are, however, also a raft of large companies where the consensus dividend yield forecasts – that is, what the analysts actually think will be paid out – are north of 7%.
As a rule, that sort of yield means the market is a lot less convinced than the analysts that the business will pay up (and right in the case of BHP Billiton’s dividend cut announced today) , which begs an interesting question – is that what the market is now saying about Royal Dutch Shell’s consensus forecast yield of 8.8%, Rio Tinto’s 8.8%, and HSBC’s 7.5%? And indeed the 5.9% consensus on Lloyds, which has not paid a dividend for six years?
There are a number of ways you can approach this issue – not least by simply accepting the market’s view that there is a very large question mark over whether or not a number of these businesses will actually pay those dividend yields. A more interesting angle, however, we would argue, is to consider the effect these levels of yield are having on the overall market.
After all, as you can see from the table below, each of those companies mentioned above ranks among the UK’s top 20 largest businesses by market capitalisation. What you can also see is that, between them, those 20 companies average a dividend yield of 5% – a material uplift on the broader UK market average, which stands at about 4%.
Source: Schroders, 2016
Even within these 20 companies – which between them, remember, make up close to three-fifths of the UK’s entire market capitalisation – there is a huge skew. At one end, are the commodities businesses and banks paying above 7% while, at the other, are what the market views as ‘safety’ – the likes of Reckitt Benckiser, SABMiller and Unilever. At yields of 3% or less though, that is ‘safety’ at a price.
To emphasise just how big an effect the UK’s largest businesses are at present having on the income-generation game, we have added extra columns to the right-hand side of the above table. Theses show the cumulative dividend and market capitalisation totals of the 20 companies – thus 17% of the UK by market capitalisation yields above 8%, 28% yields above 7% and 40% yields above 6%.
These numbers are not only pretty large, they are also potentially pretty scary. For, as the next chart illustrates, figures from the last two decades suggest the higher the average forecast dividend yield, the less likely it is the full distribution will be paid out. Here on The Value Perspective, we would certainly agree that is a reason for caution but, again, there is another way of looking at this picture.
Source: SG Cross Asset Research, 2016
Consider, for example, that 7-8% bucket, into which BP and HSBC currently fall. Yes, there is a shortfall but, on average, investors in ‘7-8%’ companies over the last 20 years have still realised a yield of more than 6%. It is a similar story with the 8-9% bucket, where at present you will find Rio Tinto and Royal Dutch Shell.
So, at a time when more than a quarter of the entire UK market by market capitalisation is yielding above 7%, you might well take the view that history suggests you would be wrong to expect the full 7%-plus pay-out. But, then again, you would also be wrong, on average, to expect all these businesses to cut their respective dividends to zero.
Some of them may well cut to zero but, on average, you might reasonably expect to see a yield that is still comfortably in excess of the 4% or so the whole market is paying at present. After all, from 7% down to 4% is more than a 40% fall, which means, as things stand, investors are building some fairly apocalyptic views on income into their thinking.
Still, while they are thinking about income, here is one last point they should factor in – as you can see from our final chart, at 24%, the percentage of UK stocks that yield more than the market is now at a 25-year low. In other words, if the UK market dividend now appears to be a reassuringly comfortable 4%, it is largely only thanks a handful of corporate behemoths.
Source: Societe Generale, Cross Asset Research, FTSE, data shown from 31 December 1989 to 30 November 2015
That reality is something on which income-seeking investors now really do need to take a view. So much of the UK market is offering unattractive yields at unattractive prices – and the consequences of picking the wrong areas to invest in are potentially disastrous. And those banking and commodities giants the market is so worried about? That is now the market dividend call in a nutshell.
Fund Manager, Equity Value
I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
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