Dividends are heating up - will they boil over?

Ed Monk
Ed Monk
Fidelity Personal Investing16 April 2018

Dividend yield shows the level of shareholder payments made by a company as a proportion of its share price, expressed as a percentage. It’s a key metric for those investing for income.

Look at the dividend yields around the UK market right now and there seems to be reason for income-hunters to get excited.

Some of the country’s biggest names are, on the face of it, offering very attractive income. Centrica, the British Gas owner, has a current dividend yield of 8.5%, with sector-mate SSE offering 7%. Persimmon, the constructor, has a dividend yield of 8.7% while Imperial Brands is offering 6.9%. Index-giant Vodafone yields 6.3%.

In a lower-for-longer world, in which an inflation-beating income is hard to come by, these really stand out. But is all as it seems? Why isn’t the world rushing to snap up shares at these levels?

Well, there are a couple of reasons. The significant share price falls we’ve seen since the start of February have made these dividend yields larger, because the share price that forms one half of the yield equation is lower. That could make the dividend on offer better value, but it also means that there are plenty of people questioning the immediate future direction of the stock market. A 7% yield looks less good if your capital loses 10%.

Perhaps even more importantly, there is a question mark over whether investors will actually get these levels of income if they buy now. Dividend yield is worked out using the most recent dividend, so in order for the dividend yield to translate into actual income, the dividend of last year needs to be at least maintained. Over the longer term, profits at the dividend-paying company need to be sustained in order keep the dividend supported.

It will no doubt prove to be the case that many of these very attractive looking dividend yields are indeed delivered upon, and that many investors will have done very well by buying now. Yet it’s also likely that some dividends will be cut. A yield of 8% is far above the 4% that applies to the FTSE 100 as a whole, and the fact that investors are not rushing to buy perhaps indicates their scepticism that a payment that high will be delivered.

These are all considerations that income investors must weigh up, and it can be hard for individuals to delve into a company’s finances to properly establish for themselves whether payments can be maintained. Active managers of equity income funds are specialists in doing exactly this job, including sifting out the genuine income opportunities from those that prove to be a mirage.

Within our Select 50 list of favourite funds, a number are equity income specialists. The Fidelity Enhanced Income Fund builds on the underlying dividend offered by its already high-yielding shares by selling the option to buy some of its shares to other investors. The premium it earns by doing this results in a yield of more than 6.6% currently, although this is not guaranteed.

The JOHCM UK Equity Income Fund currently offers a yield of more than 4%, although also not guaranteed.

It’s not all about the UK - In overseas markets, the Fidelity Global Dividend Fund has holdings in Asia, Europe and the US with a particular focus on reducing downside price risk.

Important Information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.