Beware high-yielders? All that glitters…

20 June 2017

Capital gain typically takes centre stage despite ample evidence that a compounding dividend is the real hero over the long term. Finding companies that can reward shareholders consistently is the challenge, and here it is important to not shirk proper homework.

Large yields may be flashy, but as the chart below illustrates higher-yielding companies have tended to be more susceptible to dividend cuts.


From flash to trash?

Higher yielders have higher cuts to dividends – 10 year average to 2016

This may seem fairly obvious, but a low interest rate world starved of yield – like the one we’re in – investors can be tempted to slide down the quality spectrum (or up the risk spectrum!) and this is why a disciplined approach focusing on sustainable dividends is vital. 

We have tailored our research system to ensure precisely this and believe it enables us to build a portfolio with an attractive income stream, without the dividend volatility that a less discriminating process can bring. 

Of course there are instances where high dividend yield reflects a high-quality business – one that can afford to reward its shareholders generously. But, history shows that this is likely to be the exception rather than the rule. 

Sometimes a high yield can be a symptom of distress, with the share price having moved lower in anticipation of a dividend reduction. Equally a high pay-out ratio can indicate a thin ‘margin of safety’ should business conditions turn sour. Understanding the drivers and durability of a company’s returns is therefore essential to avoid superficially appealing dividend stocks. 

Growth is our starting point

Importantly, (and contrary to many other income investors) our starting point is growth. 

We assess the degree to which a company can expand sales and convert this into earnings, and more significantly from a dividend-perspective, cash flows. 

Given the inherent difficulty of forecasting these with accuracy, it is critical to think in terms of probabilities, and to map a range of scenarios. We also conduct in-depth credit analysis to understand the robustness of the balance sheet and stress test the dividend for a deterioration in key metrics. In addition, we overlay this quantitative analysis with an assessment of material environmental, social and governance (ESG) factors that can impact a company’s performance – both to the downside and upside. 

In aggregate these checks give us a strong handle on the quality of a business and thus the likelihood that it will be able to maintain and grow distributions to shareholders over the long haul.  

So, while a high yield may offer some short-term gain, it could easily lead to long-term pain. All that glitters may not be gold.  And while there are no guarantees of success, we believe that our active research process and analysis helps us to identify companies that will pay sustainable – or growing – dividends in the future.

 

Important information

Information correct at time of publication.  This information is issued and approved by Martin Currie Investment Management Limited. The opinions contained in this article are those of the named manager. They may not necessarily represent the views of other Martin Currie managers, strategies or funds.  Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested.