Andrew Lapthorne, head quantitative equity research at Societe Generale believes that this is a distinct possibility, pointing out in a recent note that such a strict focus on yield can be counterproductive, especially in an environment, such as today where less than 25% of UK companies beat the threshold.
While Lapthorne agrees that the overall importance of dividend payments to total return is clear and well proven, a focus on sustaining dividends no matter what is decidedly not important.
In fact he says: “Buying stocks with a high dividend yield is not a particularly good investment strategy,” he said, “but we find that buying stocks with a high free cash flow yield is. It is future cash flows not the current level of the dividend that matters most.”
“Not only do companies that have high dividend yields end up cutting eventually, but the market is reasonably proficient at working out if a dividend is sustainable or not, long before it is cut.”
Lapthorne also disputes the importance of dividend cover as a measure. “It is a weak business, not a temporary poorly covered dividend, that leads to dividend cuts and weak performance,” he explained.
“Actually cutting a “bad” dividend tends to lead to better share price performance. So the job of an equity income fund, in our view, is to buy great cash flow generating businesses at sensible yields. The level of dividend is then the final part of the jigsaw.”
Yarrow agrees that cash flow is a more useful measure than current yield and he, like a number of other income mangers are more interested in dividend growth than in yield.
But, he adds: “Mid-single-digit dividend growth is probably as much as can be expected in the current environment, even from the cash generative businesses we focus on.”
Which leads us back to the question posed in the title. It is clear that dividend yields are likely to be lower than they have been in the past, especially in the large cap arena. If nothing else, managing client expectations of dividend flows is necessary. But, perhaps a reassessment of exactly what can be expected from an equity income fund is also worth doing.
