Back in the days before lockdown, when Covid-19 was still just something of which you were dimly aware, a leading fund manager told me that the virus would come to the UK and that companies would use it as an excuse to cut their dividends.
It seemed far-fetched. Not the spread of the virus, because given globalisation and people regularly visiting all corners of the world, it was likely to spread. But the idea that it would have such an impact that dividend cuts would become a sign of prudence did not seem likely.
This manager runs one of the best-performing income funds but he has, for at least two years, thought that several of those large companies, with massive dividends and beloved by many income fund managers, were heading for a fall. The dividends may be a prop for the shares, he said, but the company was ex-growth so the dividends would, at some point, become unsustainable.
Better, he thought, to buy shares in growing companies. True, these did not pay much of a dividend to start with, but they would over time. He was, in effect, a contrarian.
He was also unsure of how boards would cope with a cut, until Covid-19 changed the game. Companies in Britain usually do not cut dividends and, if they do, this creates a lasting stigma. Dividend cuts generally can only be accepted when a company is so far gone there is really no alternative.
But he also said that the UK stock market was not cheap, despite many saying it was, because there were few growth companies. Finance, bank, utility, oil, and telephone companies paid most of the dividends, but they were not growth companies. Technology businesses, where there was growth and where Britain did quite well, did not generally come to the market; and, if they did, they were snapped up quickly.
No one knows which companies will thrive and how many will perish
DeepMind, which Google bought in 2014, is a case in point. Alphabet, the parent company of Google, is building a vast facility at King’s Cross to accommodate its artificial intelligence division, which centres on DeepMind. Had DeepMind been independent, it would probably have been one of our unicorns – with a billion-pound cap. Instead, it became American. Similarly, Arm, the chip pioneer, became Japanese when it was acquired by telecommunications company SoftBank in 2016 (in September 2020 Arm was sold to the US graphics chip specialist Nvidia), and in 2003 Amersham was incorporated into GE’s Healthcare division. And so it goes on. They have done well, but they are not British.
Of course, our fund manager did not realise how Covid-19 could bring such havoc to the UK. More than 300 companies have cut or cancelled their payouts, according to broker AJ Bell, and financial administration company Link has suggested that dividends might halve this year.
Shell cut its dividend for the first time since World War II; BT cut its dividend and its share price has fallen to levels not seen since the company floated in 1984; and the Bank of England and other regulators have recommended banks and insurers cut their dividends to conserve their capital – though investors in Hong Kong have expressed outrage at HSBC for doing so. Marks & Spencer in retail, ITV in entertainment, and Stagecoach in transport are others that have cut. Vodafone also held, but it had already cut by 40% last year.
Terry Smith, another fund manager, said in the Financial Times that the 20 highest-yielding stocks in the FTSE 100 index had an average dividend cover to 1.3 times, and 1.1 times for the biggest payers. According to Smith, these companies cover roughly a third of the £100bn paid out annually. But over time cover of 1.1 to 1.3 cannot be sustained if companies want to grow, he wrote. These companies, he said, will return with a much smaller, more sustainable dividend in the future.
In a way, both fund managers are fighting the last war. No one knows which companies will thrive and how many will perish.
Many are saying that companies will have to reset. If they do, they may have to cope with far greater political and regulatory risk than they do currently, and that could easily hit the stock market. Nationalism and inequality could result in a partial ban on takeovers to stop the tech giants becoming even bigger; but this may also persuade politicians to break them up. After all, this happened when Teddy Roosevelt was US president over 100 years ago and handled the anti-trust efforts, clipping the wings of Carnegie in steel and Rockefeller in oil, to name but two. Perhaps Jeff Bezos of Amazon and Mark Zuckerberg of Facebook are due a similar clipping.
This article was originally published in the October 2020 flipbook edition of The Review.
The full flipbook edition is now available online for all members.
All CISI members, excluding student members, are eligible to receive a hard copy of the quarterly print edition of the magazine. Members can opt in to receive the print edition by logging in to MyCISI, clicking on My account, then clicking the Communications tab and selecting 'Yes'.
Once you have read the print edition, keep coming back to the digital edition of The Review, which is updated regularly with news, features and comment about the Institute and the financial services sector.