March 2012
It’s a dividend spring.
Dividends, a bit like green vegetables, are universally regarded as good for you. Though, if truth be told both can be a bit boring. The biggest difference is that while spring is a time for planting vegetables it is the season for harvesting dividends. And 2012 is shaping up to be a bumper year with large increases in dividends from companies like Anglo American, up 14%, to WPP, up 39%. None of these increases were particularly surprising to the analysts who follow these companies, which is part of the reason why the market response has been rather lacklustre.
Of course the stock market has got off to a good start with a gain over 9% since early December. But that has been led by mid and small cap stocks, not by the large cap big dividend payers suggesting it has more to do with the liquidity injection by the ECB and the Bank of England than changing perceptions of growth. Does the 35% gain in RBS over this period reflect renewed confidence in its business or just reduced concerns over a need to refund itself? Over the same period HSBC has risen just 13%, but is expected to pay out £5.6 billion in dividends the year after next. In 2013 RBS is forecast to pay out just £177 million in dividends. Which is the more attractive stock for the long term investor? That is why 6.9% of The Munro Fund is invested in HSBC and just 0.2% in RBS.
Many observers are rather dismissive of the analytical powers of analysts. Some prefer the certainty of the data in historic report and accounts. Yet a detailed inspection of the 2007 accounts for RBS would hardly have prepared you for the horror story of 2008. The two advantages of dividends are that they can never be restated and eventually you get physical confirmation by cheque. Because of that companies are usually cautious when declaring them and, especially now, only pay out what they think is sustainable. In that way they can be viewed as being analogous to a smoothed earnings per share figure.
In short, it is better to be roughly right about the future than precisely wrong about the past.
This year’s dividends are a bumper crop as the authoritative quarterly Capita dividend review had predicted. But that is in the price. More important is what will happen next and here the fundamental process used by The Munro Fund can help. As a reminder this process downloads published dividend forecasts for the next financial year and uses that to determine how much to hold in each stock in the FTSE 350. The logic for that is to be found in the Barclays Equity Gilt Study that reveals that since 1945 94.7% of the return from equity investing comes from dividends, growth in dividends and the compounding effect of reinvested dividends. Capital growth provided just 5.3% of that return, so those chasing undervalued growth shares have to work twenty times as hard to get the same result.
Fundamental Tracker Investment Management makes this calculation at the beginning of every month but the March exercise is by far the most exciting. That is because most companies have a December year end and report their annual profits in February. That is also usually when they declare their final dividend. More important for the Munro Fund is that having declared results for the previous year the model rolls forward one year and incorporates data for the next financial year. So this time around as companies report results for 2011 the model changes from using forecasts for 2012 to using estimates for 2013. This provides a good indicator of next season’s dividend crop. And the signs are good.
In February the total estimate stood at £75.9 billion but a month later, after the bulk of the results, the grand total now stands at £79.1 billion. Not only is this a jump of 4.25% but it is the highest estimate for this figure since we started calculating it in August 2007 when it stood at £73.1 billion. Back then the FTSE 100 stood at 6,500, you could get 5.75% depositing your cash in the bank or get a yield of 4.5% on a ten year gilt. Today, the index is 10% lower, cash offers nothing and gilts yield 2.4%. On our data, at the current level of the market, equities have a prospective yield before costs of 4.2%.
Ah yes, some say, but they are only estimates, analysts are known to be always over optimistic. That is true to some extent, but reconciling our forecast data to the actual amounts paid out, as determined by Capita, suggests that gap is not that big. More importantly it seems to be declining.
In 2008 analysts expected a payout of £71.0 billion. In fact they were too optimistic by £7.2 billion. In 2009 the shortfall was £12.9 billion compared to their estimate of £69.9 billion. By 2010 the message was getting through and they were only £5.4 billion above the actual figure of £55.1 billion. So far, 2011 looks more promising with a variance of only £2.1 billion from the projected £68.4 billion. And the signs are that the gap will be even narrower in 2012 where the analysts’ forecasts of £74.8 billion are only £1.5 billion higher than that of Capita’s.
Interpreting such data is not easy, but it might be reasonable to suppose that analysts, like so many of us apart from Alastair Darling, underestimated the severity of the financial crash. In any event they, and Capita, point to better times ahead. What we do know from Barclays, Professors Dimson, March and Siegel is that rising dividends are a necessary ingredient for a rising market.
By that we don’t meant the 86% gain in Ocado, the second best performing stock in the FTSE 350 this year to date. We mean steady, unspectacular gains from solid companies paying large and rising dividends.