Redwheel’s Nick Clay on why dividends deserve appreciation

by | Apr 18, 2023

At a time when energy costs, mortgage prices and just about everything else seems to be rising, the last thing many people might want to see is the news that many of the globe’s biggest companies are reporting strong profits.

Indeed, as we hit reporting season and see companies announce the return of paying dividends to their shareholders, investors and companies are likely already preparing themselves for the public backlash. The argument will go: how can it be fair that companies are rewarding their shareholders, at a time when there is a cost-of-living crisis? Should they not just be cancelling them and paying staff more?

We understand the frustration, but we believe the frustration is misguided because dividends are generally fair. Unlike share buybacks, which only benefit the very top of the company, dividends often benefit who owns a share and can benefit from the company’s growth.

This is how you can try and cope with the impact on your real wealth that a persistent inflationary backdrop generates. When you go back to the 1970s, and any other times when inflation has been high, the dividend growth from markets has been able to keep up with inflation through time, and therefore has allowed people to continue to grow their wealth. According to Bloomberg, average US CPI from Jan 1970 to Dec 1982 was 7.7%; over the same period S&P500 dividend growth averaged +7.5% annual growth.

This leads onto the second part of the argument, which again comes down to misconceptions. If we look at the energy crisis and see the news that these same energy companies are paying out big dividends again – which may be likely over the next two quarters – it could lead to lots of anger. However, this anger could quickly be dissipated once there is the realisation of the importance of these dividends to most people’s second largest asset: their pension.

The long-term driver of total return tends to be the compounding of income. If we are moving back to a more normal investment environment of cycles, volatility or inflation, people will need companies to keep paying and growing those dividends to harness that effect on their total return going forwards.

So rather than being perceived as a bad thing, we believe that paying dividends benefits all parts of society. If you are young and building up your pension, then receiving regular dividends now, which can be compounded for a good 30 years, has incredible power.

Equally, if you are at the latter stage of life and must live off the income from your pension, having a pension asset that still generates a durable income – and can grow to compensate for rising inflation – is an incredibly important aspect of ensuring your pension pot lasts long enough for a long retirement. So rather than be discouraged and being bashed, the paying of dividends should always be encouraged.

It’s important to note that in the current market, it’s not just the sector, such as energy, that offers  the biggest dividends. Instead, it will be those strong, durable companies that are likely to provide the best dividends. For example, PepsiCo distributed more dividends last year than the total value of the company back at the start of the 1980s .

There are now many companies where it is the power of these cash flows and the fact they are in an environment in which they can raise prices and suffer in an inflationary backdrop – that is allowing them to raise dividends at the same time. It is more a business type rather than a sector type, it’s about dominating a marketplace and therefore having the ability to raise prices, whether this is an energy, luxury goods or consumers staple company.

Of course, not every company who puts up prices, generates cash flows and subsequently announces a dividend has the same amount of financial strength. Take Unilever for example. It has put up its price 12.5%, while the volume is falling 2%, so the revenue is growing 10% . However, putting up prices does mask a lot of things, and the halo effect rarely lasts long. Eventually it is unsustainable for certain companies who don’t have the product to back it up, and we would argue this is the case for Unilever.

In these cases, we understand there will be a public backlash, but what we are trying to argue is that in conditions where you can no longer get rich over the weekend, dividends are not something to be bashed, but instead potentially treasured.

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