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.

This article first appeared in the Telegraph.

NOWHERE is the return to normality clearer or more welcome than in the restoration of company dividends. For yield-focused investors the past 18 months have been a testing time, but 2021 looks like being easier for those who care as much about the income from their investments as how far and fast they will grow. As index-linked final salary pensions become just a fond memory, that will be most of us in due course.

BP’s recognition this week that it must balance its pivot to renewable energy with satisfying the needs of income-hungry investors has obviously been made easier by the return of the oil price to pre-pandemic levels. It is a reflection of the higher rewards that investors now demand as compensation for sticking with an industry with an uncertain future. But the clarity of its promise of a 4%-a-year dividend hike to at least 2025 is still welcome news.

And BP is not alone. Last week, Shell unexpectedly hiked its quarterly pay-out by 38%. Rio Tinto’s £9.1bn interim and £3bn special payment mean the miner has already paid out more than it did in the whole of 2020 and is on track to be the FTSE100’s biggest dividend payer this year. HSBC is restarting its dividend and considering share buybacks.

Just as earnings are benefiting from extremely favourable year-on-year comparisons, dividends would struggle not to look good when compared with the second quarter of 2020. With the Bank of England obliging banks to cancel their dividend payments this time last year, and other companies deciding they had no choice, the pandemic was hard work for anyone living off their stock market investments.

But the last three months has seen a 51% rise in dividend payments, according to the latest data in the Link Group Dividend Monitor, far more than expected. There is clearly a one-off element to this recovery. The lion’s share of the increase has come from companies that cut their payments last year and have now returned to the dividend list. There’s also been a string of catch-up special payments. The second half will no doubt see a resumption of more normal service.

There has arguably never been a better time to be putting together an income-paying portfolio of shares. If companies ever needed the cover to reduce an unsustainable pay-out, the pandemic surely provided it. If a board of directors has not taken the opportunity to rebase their company’s dividend to a level from which they can deliver steady year on year increases into the future, they have probably been asleep at the wheel.

This recalibration is evident from Link’s upgrade in its forecast dividend growth for the whole of 2021 to 24% and the way it has brought forward to early 2025 the point when it expects dividends to reach their pre-crisis high. It is also clear from the more comfortable levels of dividend cover we are routinely seeing. It is now commonplace to see every £1 of dividend supported by £1.50 of earnings.

With earnings growth forecasts for the third and fourth quarters continuing to rise, and next year’s estimates being nudged higher too, the outlook for higher dividend payments has rarely looked more secure than it does today.

One reason for this is the fact that the UK’s traditional dividend-paying sectors are among the chief beneficiaries of our emergence from the pandemic. Banks are in a strong position to increase their pay-outs now they have the regulatory green light to do so, as they benefit from an economic upturn, fewer bad loans and wider profit margins on the back of a bigger gap between short and long-term bond yields. An improving housing market helps too.

Mining companies are the clear winners from the happy combination of an economic rebound, more government spending and a green, build-back-better agenda. Years of underinvestment means that bridging the gap between supply and demand in that environment will inevitably lead to higher prices for natural resources.

The oil and gas sector may be the least attractive of the three from a long-term perspective during the twilight years of the fossil fuel era. But we will be burning hydrocarbons for many years to come and investors will demand more of their return in the form of dividends today than capital growth tomorrow. This naturally presents a dilemma for investors who want to do the right thing with their money, but it is a better problem to have than wondering how your pension pot is going to sustain you for the next 30 years.

None

Once you’ve satisfied yourself about the provenance of your dividend income, there are two further considerations. Both are lessons from last year’s equity income drought. The first is to protect yourself from company or sector specific problems by ensuring that you are well diversified both within a market and globally too. The UK is a great source of dividend income, but the yield is concentrated, with just 15 companies accounting for well over half of the total dividends paid in the most recent quarter. A global income fund can get around this problem and provide access to income in sectors where there is none in our domestic market.

Your dividend income will also be a great deal more sustainable if you avoid wishful thinking. There is usually a good reason why a company seems to be offering a well above-average yield. Most often it is because the dividend from which it is calculated will never actually be paid. That risk is lower this year than last, but it remains the case that a yield above, say, 6% is telling you something you may not want to hear. It’s a good time to be an income investor, but there are still no free lunches.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. 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. 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 a Fidelity adviser or an authorised financial adviser of your choice.

Share this article

Latest articles

Watch: Market News Update - 16 May 2022

In this week’s market update: another down week for shares; bond markets catc…


Tom Stevenson

Tom Stevenson

Fidelity International

Market news today - Contrarians sense a turning point

What’s driving your investments this week?


Tom Stevenson

Tom Stevenson

Fidelity International

How to turn a profit in the post-Covid market

A bigger state and rising inflation means it really may be different this time


Tom Stevenson

Tom Stevenson

Fidelity International