With the Bank of England having cut base rate to stave off the prospect of a severe slowdown in the UK economy following the credit crunch, UK income stocks may be set to perform well relative to growth stocks in coming months.
The merits of income stocks come to the fore in turbulent markets and a flight to safety can occur. Investors welcome the comfort and predictability of substantial and regular dividend payments in periods of highly volatile, uncertain markets.
The arguments behind investing in UK income stocks can be extended to the global arena, with the added attraction of enhanced geographical and sector diversification.
Markets and sectors not previously known for embracing a dividend-paying culture have been increasing their dividend payouts. In the US, a change in tax laws in 2003 that saw the tax cut on dividends has led companies to increase their dividends. In Japan, the dividend payout rate has started to climb, admittedly from a very low base.
Even the technology sector is observing change. Microsoft, as well as paying a one-off special dividend, has begun to issue regular dividends. The Taiwan Semiconductor Company, a world-class manufacturer of semi-conductors that generates a return on equity of over 20 per cent, has altered its dividend policy so that it now pays a 5 per cent dividend.
These trends mean that it is now far easier to create a global portfolio that is fully diversified along geographic and sector lines with a strong focus on yield.
The relative appeal of pure UK income investing versus global income investing is also declining. As the world begins to catch up the UK in terms of dividend payments, the UK yield advantage has dwindled. With the growth rate in world dividends running at 13.1 per cent over the past five years, including 25.1 per cent across emerging markets, the historical yield advantage of UK stocks, which have experienced a more moderate 7.2 per cent dividend growth rate in the same period, is being eroded. Furthermore, global opportunities are much wider than those offered by the UK stockmarket. There are over 500 companies in the MSCI All Countries World index that have a yield greater than the average yield of the FTSE All Share index.
The quest for yield concerns many UK investors. It seems that global stockmarkets now afford abundant opportunities to find this yield. However, the search for income does not necessarily have to come at the expense of growth.
Companies paying high dividends have performed well over time. Global stocks with the highest yields have outperformed dramatically those with the lowest yields during the past 16 years. Moreover, a study published in last year’s Financial Analysts Journal found that high-dividend companies tend to generate higher earnings’ growth.
This is perhaps surprising but an analogy from the high street helps to explain this apparent paradox. Too much money jangling in your pocket when you hit the shops bent on buying the latest flat-screen TV might not necessarily lead you to make the most efficient and appropriate decision. It is the same for companies, it seems. Management teams flush with cash often make poor investment decisions that result in low returns.
In contrast, management teams of high-dividend companies seem to be superior stewards of capital, having less of a propensity to engage in value-destroying acquisitions or implement ill-conceived projects. The capital discipline needed to pay a regular dividend focuses management on generating consistent cashflow and reinvesting in their business prudently, leading to capital gains.
Going global in the pursuit of yield makes sense and one need not sacrifice capital growth to do so.
There are exciting income opportunities across global stockmarkets in a range of sectors and investors can get exposure to high-dividend stocks across the developed and emerging markets. These markets can offer substantial and reliable dividends combined with the prospect of capital appreciation. UK investors seeking income can now start to look on the global stage.