Dividend discovery

Alex Crooke, Head of Global Equity Income at Henderson, on what dividend growth can show and why payout ratios remain supportive

Consistent dividend growth is generally a sign that a business is doing well and should provide investors with a degree of confidence. If dividends are rising steadily over time, then a firm’s earnings, cashflow and capital should also be growing.

Sustainability ratio

Payout ratios identify the percentage of corporate earnings that are paid as dividends and can be an indicator of whether a company has the scope to maintain or increase dividends. The payout ratio can be influenced by a number of factors, such as the sector the company operates in and where the company is within its growth cycle. As the graphic shows, the level of current payout ratios varies considerably between countries and regions, both at an absolute level and when compared to historical averages.

Although the chart shows that opportunities exist for dividend increases in the emerging markets, the outlook for earnings and dividends remains uncertain and at present we are finding the most attractive stock opportunities for both capital and income growth in developed markets. Within the developed world, Japan and the US have the greatest potential to increase payout ratios, although from a relatively low base, with both markets currently yielding around 2 per cent.

Company selection

Conversely, payout ratios from certain markets, such as Australia and the UK, are above their long-term median.

The 2016 forecast yield for Australia is 5.2 per cent and for the UK 4.4 per cent. Companies from these countries are distributing a greater percentage of corporate earnings to shareholders in the form of dividends than they have done historically. This leaves the potential for dividend cuts if a company is struggling to grow its earnings.

One area of concern for income investors with exposure to the UK and Australia is the number of large resource-related companies listed within these market indices. We believe that earnings, cash flow and ultimately dividends from these types of firms are likely to be impacted by recent commodity price falls.

Nevertheless, the UK in particular has a deep-rooted dividend culture, and outside of the challenging environment for the energy and resources sectors is home to a number of businesses that are delivering sustainable dividend growth. Our approach is to invest on a companyby-company basis using an activelymanaged process that considers risks to both capital and income.

Seeking dividend growth

We continue to seek companies with good dividend growth, and payout ratios that are moderate or low, which provides the potential for dividend increases. Typically, we avoid the highest-yielding stocks and focus on a diversified list of global companies that offer a sustainable dividend policy with yields between 2 per cent and 6 per cent.