Why dividends matter
17th May 2022
In this month’s Insight, Mark Barnett discusses the importance of dividends during periods of market volatility.
I believe equity markets have been in a difficult mood in 2022. They appear fearful and skittish from one day to the next where company news flow is received with a more sceptical eye and outlook statements are analysed through a pessimistic lens regardless of the tone from the management. Current sentiment is characterised by flat share prices for companies that beat sales and earnings forecasts and much more severe reactions for companies that are in line or miss expectations. The recent mindset appears to be that corporate management teams are less well informed than the collective wisdom of investors and if Chief Execs and Finance Directors can’t see any dark clouds on the horizon it’s only a matter of time! I don’t wish to understate the negative global backdrop that we are currently witnessing as there’s clearly a lot of bad news around which the news media seems keen to emphasise daily: the war in Ukraine, rising inflation and interest rates, cost of living crisis and ongoing supply chain disruption in the post pandemic world exacerbated by China’s ongoing zero COVID policy. Since the start of the year, I believe the change in mood has meant that investors seem to contemplate two factors which have been absent from their portfolios in recent times: falling share prices from stocks and sectors which have provided the most significant returns of the past few years and the reappearance of much greater day to day volatility.
Median Day 1 Performance Of Stocks Around Results Announcement (%)
Source: Morgan Stanley, May 2022
The investment world doesn’t look quite so reassuring and especially in contrast to the extreme low volatility of the past few years when most risks seemed to be acceptable and profitable, and even at the onset of the COVID pandemic the initial period of market weakness soon passed. The reality is that as many of the restrictions around the world were lifted at the beginning of 2022, it appeared that we were witnessing a more inflationary environment combined with the starting point of the lowest interest rates ever! This is not a helpful combination coupled with a shift in Central Bank mentality, but makes the current bout of increased market volatility more understandable. The chart below encapsulates the point here.
Equity market volatility as represented here by this 10-year chart of the S&P500 VIX (volatility) index was exceptionally constant for extended periods of time over the past decade, and it appears investors may have become accustomed to a scenario where share prices were becalmed under almost any economic or political backdrop. Although the volatility understandably spiked in 2020 due to the onset of the pandemic you can see how even that event failed to sustain volatility for long as the long-term pattern resumed last year. In the first five months of this year, it appears that the days of low volatility may be over for the time being and although we have seen this before for a quarter or two, the daily volatility at both index and stock level does seem to be more sustainably elevated.
S&P 500 VIX index
Source: Bloomberg, May 2022
However, it is worth remembering that notwithstanding the rapid movements in share prices, as an equity investor I believe there are some constants that you can fall back on which should provide support for a company valuation. The dividend is perhaps the most tangible form of return that equity owners receive and may be seen as the bedrock of shareholder return over the long run and especially so in choppy markets. It’s perhaps more useful to understand the importance of the dividend by thinking about private businesses which obviously don’t have a daily traded share price that provides an instant valuation for the business. If you were investing in a private business, you wouldn’t necessarily be overly interested in the daily changes in value of the business, partly because that information was unavailable. But you should perhaps be interested to understand how the business was trading, were costs moving up or down, faster, or slower than sales. You might ask about plans for business expansion and how much cashflow was being generated and you would probably want to know how all of that was going to impact the dividend you received if the business was able to pay one. But I imagine the lowest priority on your list of questions, if it was there at all, would be how much the business is worth. It’s perhaps just not relevant for a long-term investor who isn’t trying to sell their shareholding.
I believe the same logic should apply for the long-term investor in the UK stock market. It’s difficult to ignore share prices which are fluctuating wildly from one day to the next, but I think this is a distraction for investors who are holding on. In fact, you could argue that falling share prices represent an opportunity rather than a curse: an opportunity to increase your holding in a company which you know and like for the long term. What makes the UK market particularly attractive now is the visibility and certainty of a 4.1% dividend yield for 2022 which is covered 2.3 times by earnings1. Given the breadth and depth of the dividend reset during the pandemic I would have great confidence in the sustainability of that yield. The yield on my new portfolio, TM Tellworth Income and Growth, is currently even higher at 4.6% with equivalent levels of dividend cover and the prospect of double-digit growth on top2. To me, this seems like an attractive and tangible return from owning the portfolio now and, hopefully, should give all of us with a financial interest in the Fund, a reason to feel reassured that despite volatile share prices the monthly dividend cheques will keep coming.
2 Tellworth, as at 16/05/22
The views and opinions contained herein are those of Mark Barnett. They do not necessarily represent views expressed or reflected in other BennBridge investment communications or strategies and are subject to change.
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