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Investors should focus on tobacco and utilities, says SVM

SVM Asset Mangement global opportunities co-fund manager Colin McLean says investors should rebase divdend expectations and recognise the merits of slow but steady dividend growth in sectors such as tobacco and utilities.

He says the recent dividend cuts from banks and other household names will hit investors hard.

He says: “They follow more than 12 months of poor share price performance from high yielding areas of the stockmarket like banks and consumer stocks. Should investors looking for equity income change their approach? Surprisingly, portfolios focusing on yield may actually prove particularly risky as the economy slows down.”

McLean adds: “Even a 15 year record of dividend growth can end dramatically. Over that period, Royal Bank of Scotland grew its dividend at a yearly average of more than 17 per cent. Its high dividend yield became the main attraction of the shares in recent years – big dividend payouts offset lower share price performance.”

He points out that all that ended with the rights issue. Far from being in a position to grow dividends, RBS now wants money back from its investors.

“Royal Bank’s next interim dividend will be paid in shares – which for many will look like erosion of capital – and the company has merely stated a “current intention” to pay next year’s final dividend in cash. Investors should expect this pattern of dividend cuts to be repeated by many other UK banks.”

McLean warns that the price of the public money supporting the bank sector is likely to be the sharing of the pain. Shareholder dividends and executive bonuses may suffer alongside the taxpayer.

“Investors hope that dividends will grow in real terms, after inflation, helping protect living standards longer term. Investors assume that dividends paid are not eroding a company’s earning ability for future years. Yet, because dividends are paid from cash rather than from earnings per share, they should be questioned even where earnings per share look healthy. A cut in dividends is usually the last signal of problems, with boards fearful of shareholder reaction. “

He adds: “The pain of a dividend cut on a high yielding share can be greater than most, if the yield has been propping up the share price. A much higher than average yield is the market’s way of telling companies to do exactly that. Boards are being advised to cut, as the market does not rate the sustainability of the high yield. “

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