Really bad news on dividends is yet to come says Terry Smith

Even as Shell cuts its dividend, there were warnings from financial experts that worse news is still to come for dividend hunters and that income investors should remain measured in their approach.

As of Thursday, 41 of the constituents of the FTSE 100 have cancelled or paused their dividends for 2019 or 2020 after  PLC’s () first cut since World War II.

Assuming that Shell sticks to its reduced quarterly dividend and that other companies who have scrapped their payouts pay nothing at all across the whole year, then the FTSE 100’s aggregate dividend is still forecast at around £54bn, according to calculations from AJ Bell, down from £75bn in 2019 and not including special dividends.

Star stock picker Terry Smith said he suspects, however, “that the really bad news for equity income investors is yet to surface”. 

Dividend cover on the top 20 highest dividend yield stocks in the FTSE 100 standing at just 1.3 times earnings as of mid-April, while for the top 20 largest dividend-paying stocks in the UK it was 1.1 times.

In other words net profits are only around 10% more than the dividend.

Dividend cover cannot be sustained at 1.1-1.3 times over time for most businesses, Smith pointed out, as most companies need to keep hold of their earnings and cash in order to grow, with cover of two times considered more normal.

While many investors have been wondering when things will ‘get back to normal’, “this ignores the fact that what came before the crisis may not have been normal,” Smith said in a blog that was published on the FT and his Fundsmith website. 

Directors of companies that have scrapped their dividend will “not be allowing a good crisis to go to waste and will return with a much smaller and more sustainable dividend which will mean much lower yields for equity income investors”, Smith said.

This fits in with other suggestions that the landscape for dividends in the coming few years may be altered for various reasons.

A return to previous levels of dividend payments is not likely to come without angst for any companies that have accepted government aid, from business rates, VAT relief or the furlough scheme, with suggestions that the dividend landscape may be permanently altered with less cash available for payouts due to regulatory or tax demands.

Smith — while dismissively saying that “no one should invest in equities for income” — suggested that if investors were determined to do so there were better ways to try and guarantee income, principally investing for “the highest total return you can achieve and sell whatever shares or units you need to provide cash”. 

But as many investors do not like the idea of selling part of their capital to provide income, he said an alternative option for dividend income was to invest alongside a family-controlled…