Dividends are the great unsung heroes of equity investing. Too many investors fail to recognise their merit, as they pin their hopes on building wealth from rising share prices instead.
Yet, over the long term, dividends will generate a huge chunk of your overall investment returns. Like all unsung heroes, you only miss them when they’re gone.
Investors are missing them now, as the Covid-19 pandemic has forced global companies to axe dividends totalling more than $100 billion (Dh367.3bn). They will be back, but you might have to be patient.
Dividends are the regular payments companies make as a reward for holding their stock, paid either quarterly, half yearly or annually.
Shareholder payouts are not guaranteed but most companies look to increase theirs every year, which gives investors a rising income over time.
Ideally, you should reinvest your dividends back into your portfolio while working to build your wealth, but you can draw them later as income when you stop working.
Figures from fund manager Schroders shows just how valuable dividends can be. Over the 20 years to December 31, 2019, the UK’s FTSE 100 index rose by just over 600 points to 7,542, a rise of just 8.8 per cent.
If you had reinvested all your dividends for growth, your total return would have been 122 per cent, an astonishing difference.
The impact is less dramatic in the US, where dividends have been lower and capital growth higher, but you still can’t ignore them.
While global markets have recovered most of their losses from the stock market crash in March, dividends are still well down.
Total global payouts plunged 22 per cent to $382.2bn in the second quarter, down $108.1bn on the same quarter last year, according to the Janus Henderson Global Dividends Index.
More than a quarter of dividend-paying companies either cut payouts or cancelled them outright, in a bid to save cash and protect their balance sheets during the fastest recession in history.
Europe and the UK were the worst affected regions, where underlying payouts fell by two fifths, with Asia and Australia also hit hard. Japan, the US and Canada proved relatively resilient, the figures show.
Healthcare and communications companies were least likely to cut their dividends, while companies in the financial services and consumer discretionary sectors were most at risk.
There could be more pain to come. Janus Henderson’s worst-case scenario is for headline payouts to drop 23 per cent across 2020 to $1.10 trillion, about $328bn less than last year.
While this makes it harder for you to build the wealth you need for a comfortable retirement, all is not lost.
Janus Henderson’s investment director for global equity income, Jane Shoemake, says lower payout ratios in North America have made it easier for companies to maintain dividends, with many preparing to cut back on share buybacks instead.
European dividends should rebound next year, she says, but the UK recovery will be slower. “Several companies, not least oil giants BP and Royal Dutch Shell, have taken the opportunity to reset their payouts at a lower level.”
Ms Shoemake says investors should still receive more than $1tn of dividends both this year and next, despite the cuts. “A temporary dividend halt does not change the fundamental value of a company, though it can affect short-term sentiment.”
Separate research from online wealth platform AJ Bell shows that 31 FTSE 100 companies have slashed or suspended their payouts this year, although 26 have either stood by theirs, or in some cases, increased them.
Big banks Barclays, HSBC and Lloyds were effectively ordered to stop their payouts by the UK government, while mining giants Glencore, BHP Group and Anglo American all cut theirs.
In the US, bank Wells Fargo, Estee Lauder, Gap, cruise operator Carnival, cinema firm AMC Entertainment, oilfield services giant Schlumberger, aircraft maker Boeing, hotel chain Marriott International and Delta Air Lines were among those to cut dividends.
In Europe, dividends fell by 45 per cent, with the big banks suspending payouts, including ING Group, Unicredit and ABN AMRO.
Perhaps we should be more surprised that so many companies continue to pay dividends, including tech giant IBM, wireless mobile specialist AT&T and PepsiCo in the US.
UK pharmaceutical companies AstraZeneca and GlaxoSmithKline, household goods giant Unilever, mining firm Rio Tinto and British American Tobacco all stuck by their payouts.
Buying individual company stocks is always risky and most investors spread the risk with a mutual fund or exchange-traded fund (ETF), which gives them a balanced portfolio containing dozens of companies.
The popular SPDR S&P US Dividend Aristocrats UCITS ETF invests in companies on the US S&P 500 that have increased their dividends every year for at least 20 years. It yielded 2.47 per cent at the end of July, with charges totalling 0.35 per cent a year.
Similarly, SPDR S&P Euro Dividend Aristocrats UCITS ETF targets European stocks that have either increased or held payouts stable for at least 10 years. It yields 3.7 per cent, with charges of 0.30 per cent.
SPDR S&P UK Dividend Aristocrats UCITS ETF yields 4.93 per cent, reflecting more generous UK dividend policies. For example, its top holding, insurer Phoenix Group Holdings, now yields 6.75 per cent, while British American Tobacco yields an incredible 8.12 per cent.
Christopher Davies, chartered financial planner at The Fry Group, says investors should not just focus on the headline yield, as a generous dividend is often a sign of a company in trouble.
Yields are calculated by dividing the dividend per share by the share price. So, if the company pays $5 per share and its stock trades at $100, the yield is 5 per cent.
If the company hits trouble and its share price crashes to $50, the yield will fly to 10 per cent. A double-digit yield looks tempting, but is risky and rarely sustainable.
Mr Davies says many companies continue to stand by their dividends even when they can’t afford it to keep investors happy.
One way of checking whether the dividend is sustainable is to look at how well it is covered by earnings. Ideally, a dividend should be covered twice, although many investors are happy to accept a lower cover of about 1.5. Once it falls below one, the company is effectively borrowing money to reward shareholders.
Mr Davies says: “You can get decent dividend yields but don’t just chase the yield.”
As governments and central banks battle to stimulate the economy, Mr Davies says the most sustainable dividends can be found in the infrastructure sector, as well as consumer staples, where demand is more steady. “Companies with high cash reserves are also most likely to sustain shareholder payouts.”
He recommends diversifying your portfolio across a range of stocks and other asset classes to protect yourself against any further cuts.
Stuart Ritchie, director of wealth advice at AES International, says it's best not to abandon a stock simply because it has dropped its dividend. “If this helps to preserve financial stability, you should support the company’s management.”
Last year, indebted telecoms giant Vodafone Group slashed its dividend by 40 per cent, but its share price actually rose as investors felt the new 5 per cent yield was more sustainable.
While dividends are a great source of income, Mr Ritchie says retirees should not rely on them altogether. “Companies are not immune to going bankrupt and dividends are not guaranteed.”
Like all unsung heroes, dividends can go through tough times. Slowly, though, they are fighting their way back, with seven FTSE 100 companies already restoring theirs. Soon, it may be time to start singing their praises again.