Dividend payments have become more uncertain during the current pandemic-induced economic stress. Against this backdrop, companies are reassessing their ability to make payouts and certain regulators are urging the financial sector to suspend dividend payments. However, over time, earnings and dividend payments should return to pre-crisis levels and companies with strong market positions, managements and financial structures should likely generate the best future returns.
The economic decline induced by the current pandemic is proving to be so damaging to the prospects of some companies and earnings that it is precluding dividend payouts from such companies. As a reaction to this, there has been net selling of products with dividend factor exposures (Figure 1).
Where financials are concerned, regulators in some jurisdictions have even requested that banks and insurance companies suspend or pare back dividend payouts for a set period of time.
The Europeans have led the way on this – the European Central Bank (ECB) has directed that banks suspend all dividends and share buybacks until 1 January 2021, extending the period of dividend drought from 1 October. The move is to be reviewed in the fourth quarter and the outlook for dividend payments beyond 2020 is to be data dependent.
Although the ECB’s assessment is that the banking sector is resilient overall, it does not want banks to end up acting pro-cyclically. Hence, banks have been given the flexibility to rebuild their capital buffers and provide against a rise in non-performing loans.
In the United States (US), despite additional restrictions imposed by the US Federal Reserve (Fed) in its stress test in June, most banks are expected to be able to continue their dividend payouts in the third quarter. However, there are a few special situations where dividends are restricted, and it is possible that dividends will not be allowed to be increased from their current levels through the first half of 2021. The Fed will once again consider the issue in the fourth quarter as it conducts an additional stress test on the banking system due to the COVID-19 environment. The Fed’s action will also likely be dependent on the path of the economy at that time.
Dividend Yields Across Regions
Dividend yields have always varied across regions (Figure 2).1 For instance, US dividend yields have historically been low relative to other regions and have tended to hold to the 2.0% level over time. US companies invariably use other tools to return cash to shareholders, including share buybacks and special dividends.
In contrast, long-established and mature UK energy and financials companies have traditionally made substantial dividend payouts. Pension funds are large holders of their stock and have demanded such payouts. More recently, stock prices of these large UK-listed companies have underperformed other sectors and their dividend yields have risen. This in turn has driven the overall dividend yield for the UK market.
Japanese companies continue to operate with relatively conservative dividend yields and payout ratios despite investor pressure. Emerging market companies seem to have been conserving cash for future growth in terms of payout, but their dividend yields are more substantial.
Prospects for Dividend Payments
The pattern of future cash dividend payments will depend on a variety of factors in the near to medium term.
Sector considerations will be important when looking at recovery from the pandemic-induced crisis:
Food and pharmaceutical companies, which have strong and diversified global revenues, will likely continue to pay dividends despite the crisis. Nestle and Roche are good examples of this.
Cyclical companies that are exposed to the investment or capex cycle – such as industrial and certain materials companies – may be obliged to wait until a more stable economic environment is restored before returning to paying dividends.
Some companies may find earnings impaired for many years to come and will therefore be unable to pay dividends – for instance, in the energy, airline and hospitality sectors. BP and Royal Dutch Shell both decided to slash their cash dividend payouts, reflecting challenges in the energy sector.
In financials, as already noted, regulators will have a role to play. Where investors are concerned, the ECB could have given a clearer picture of the criteria under which dividends are to be resumed. This is the case with the Fed as well, where its pending review could weigh on bank share prices until there is greater clarity on future dividend payments.
More mature companies with stable growth in both revenues and profitability and limited investment needs could make more cash available for shareholders. These companies could commit to a fixed and regular dividend policy or even commit to grow their dividends. However, such companies are relatively scarce and their very stability in this environment makes their stocks highly rated.
Growth companies generally invest all their earnings back into their business in order to facilitate growth. They tend to not pay any dividends but instead opt for share buyback programs (which boost earnings per share via a reduction in the company’s share count). One example is Alphabet, which continues to prioritize substantive share buybacks.2
Payout ratios may not always be indicative of the true capacity of a company to pay. For example, in the United Kingdom (UK), where energy companies have high non-cash expenses such as depreciation, assessing the sustainability of future operating cashflow generation might be a more appropriate measure of the ability to pay.
In a world with even greater uncertainty, some companies may resort to implementing share buybacks or other such programs instead of making cash payments to shareholders.
Over time, earnings and dividend payments should return to pre-crisis levels. However, this will only occur when corporate boards are relatively certain that their earnings are robust and are back on a stable growth trend.3
In the meantime, the US and other countries that have large defined benefit plans alongside substantial equity exposures could find themselves with an income shortfall, which could be difficult to offset.
The strongest signal on dividends should come from company managements themselves. In our view, our process is tailored to anticipate this bottom-up, using our Confidence Quotient (CQ) tool. We believe CQs can help test the robustness of an earnings model – all things considered, companies with strong market positions, strategic management and healthy financial structures are the most likely to generate good returns and payouts in the future.
1Tax rates will also have an effect on dividend payout policies across different jurisdictions. For example, capital gains tax rates may be below dividend income tax rates, leading to investor preference for buybacks over dividends. Note that dividend yields are influenced by a company’s share price as well as the amount of dividend paid by a company.
2Share buybacks give a lift to earnings per share and help improve the valuation of a stock, which is another way of delivering returns. Share buyback programs can more easily be stopped or restarted than dividend payment programs, and this flexibility makes them an attractive tool for companies.
3In a normal economic environment, company boards should not commit to a dividend policy that they cannot maintain. Rescinding a decision to pay could be detrimental to management credibility and therefore stock prices.
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