Octopus Investments published their second Dividend Barometer, a report which explores the lesser-known dividend credentials of UK small and mid-caps and the ‘double discount’ opportunity for UK equity income investors. The report can be seen below:
- The ‘double discount’ opportunity: Earnings growth and valuations are disconnected, presenting a significant opportunity for investors in UK growth companies, especially when you look at smaller companies which are trading at an 18% discount to the FTSE100 (compared to an average historical discount of 9%)
- Dividend cover has increased for every index except the FTSE 100, which has decreased. Dividend cover for the FTSE 100 is lower than any other index. This gives small and mid-cap companies scope to grow their dividends ahead of larger FTSE 100 companies.
- Dividend growth remains stronger away from FTSE 100. AIM dividend payouts are now significantly higher than levels seen during Covid-19, growing by almost 75% since 2015. FTSE 250 indices have bounced back from pre-Covid levels too. This performance is largely being driven by underlying earnings growth.
The ‘double discount’ opportunity
Solid trading continues to be reported across small and mid-cap stocks. Companies are well capitalised, and the outlook remains solid, with the potential for interest rate stabilisation. Yet valuations remain at a material discount to historic levels.
This presents a significant opportunity for UK equity income investors.
UK equities are now trading close to a 40% discount to the rest of the developed world. The FTSE 100 is at a material discount to long term average multiples. This can be seen starkly in the following charts.
But UK equities appear even more attractively priced when you look at smaller companies. These, despite strong underlying performance, are trading at a significant discount to an already cheap UK equity market.
With UK equities trading at a discount, growth companies look to be an extraordinary opportunity. Looking at the FTSE Small Cap EX IT and FTSE AIM indices, there is a significantly better growth profile. Growth rates of around 20% are comfortably ahead of the FTSE 100. What’s more, these companies are offering a similar earnings profile to Nasdaq at half the price to earnings multiple.
Renewed support for UK growth companies
Chancellor Jeremy Hunt’s Mansion House speech in July announced some interesting reforms to pension policy. The Mansion House package aims to attract £50 billion into high growth assets by 2030 and re-assert the London Stock Exchange as a primary listing venue for rapidly growing businesses.
Following the speech, Simon French, Economist at Panmure Gordon commented that: “the UK’s Mansion House Compact has set in motion those rarest of things — an expectation of structural inflows into UK Small and Mid-Cap equities”
While we know that we won’t see an instant rush of inflows and there are details that need to be ironed out, these reforms could provide a growing base of support for UK growth equities, as well as:
- Make it easier forsmall companies to raise money.
- Drive a transformation in the UK from“old economy” into a research-intensive innovation hub, a far cry from the perception that the market has earned in recent years.
Chris McVey, Senior Fund Manager commented:
“What our Dividend Barometer shows us is that smaller companies offer investors arguably the best of both worlds, with a sustained and growing dividend stream, as well as a once in a cycle opportunity for capital growth recovery. What’s more, the smaller company indices offer a better forecast earnings profile to Nasdaq and yet are currently trading at half the price to earnings multiple. We hope that our Barometer highlights why investors should look more closely at small and midcap income stocks, as the market recovers from where we are today.”
Growth standing strong
Dividend growth remains stronger away from FTSE 100. Mid cap is growing ahead of AIM, but we are seeing mid-teens growth for both.
AIM dividend payouts are now significantly higher
than levels seen during Covid-19, growing by almost
75% since 2015. Both the AIM and FTSE 250 indices
have bounced back from pre-Covid levels. The
FTSE 100 and FTSE small cap indices, however, are 4 lagging behind.
This performance is largely being driven by underlying earnings growth. Many AIM and FTSE 250 companies have stronger balance sheets and are in a more exciting stage of development. By buying high-quality growth companies, you can expect attractive dividend yields.
