Dividends are normally a reliable indicator of company health. Most of the time, dividends are paid, only cut in the direst of circumstances. Company shares frequently suffer very badly when this happens so during most market crises, dividends are very rarely reduced. To put this into context, during the 2008 financial crash they fell by about 10%, which by historical standards was an exceptional fall.
Most of the time, dividends are maintained even in challenging economic circumstances. However, the current situation is so extreme that dividends across the market are forecast to be cut by between 30-60%. Much of this is dependent on whether the oil majors are able to sustain their dividends. This makes it very difficult for investors to gauge what a fair market valuation might be, as all standard valuation parameters (such as earnings and dividends) are no longer reliable reference points.
So why are companies cutting dividends? In broad terms, the answer lies in one of three camps. Those companies which find themselves in the forefront of the economic collapse, such as hoteliers, travel businesses and hospitality industries, are being forced to cut dividends. They simply do not have the money to be able to pay-out to shareholders. Other companies are perhaps less affected by the Covid-19 outbreak, but nevertheless feel it is prudent to retain cash on their own balance sheets rather than to distribute it to shareholders. This is a precautionary measure to ensure that the business can be sustained and will not have to turn to shareholders for additional funding through the likes of rights issues. Thirdly, certain businesses have been forbidden from making dividend payments by the regulator, namely banks. They have a regulatory obligation to ensure that they remain fully capitalised and in the best possible health to guarantee that they are able to distribute capital and loans to industry across the UK.
All this means is that investors who are looking for a consistent income from their investments will, at least in the short term, be disappointed. Therefore, they may need to look towards other areas for their income requirements or potentially take income from their capital depending upon their individual needs.
Source: Square Mile Investment Consulting and Research Limited. Investment Partners to Ernest Grant.
Important Information: This document is issued by Ernest Grant Limited. Ernest Grant Limited makes no warranties or representations regarding the accuracy or completeness of the information contained herein. Nothing in this document shall be deemed to constitute financial or investment advice in any way. This document shall not constitute or be deemed to constitute an invitation or inducement to any person to engage in investment activity. Past performance is not a guide to future returns and the value of capital invested and any income generated from it may fluctuate in value.
