before the dividend can be restored unless the company receives permission from the High Court for a capital restructuring.
Cash is king
To emphasise, the company must actually have cash available to pay dividends. Profits on paper are no use in this respect. Your house may be worth twice as much as you paid for it but you cannot spend any of that gain unless you actually sell it. Similarly companies may make profits on paper, say from the revaluation of assets, but cash is king.
These rules apply to all companies, irrespective of their size or sector. You may find that companies with heavy capital costs, such as manufacturers and plant hire companies, build up larger distributable reserves to conserve cash. Companies with erratic profits will also want to keep sizable reserves so that they can maintain a steady dividend in good years and bad.
In contrast, companies with strong cash flow and low debts will find it easy to dish out the dosh.
Dividends can grow even in hard times
Total dividends paid by UK quoted companies actually grew in 2008, after the scale of the credit crunch had become only too apparent, to £67.1 billion from £63.1 billion in 2007. That is a lot of money for non-investors to be missing out on.
Admittedly, dividends were scaled back in 2009, to £58.4 billion, and again in 2010 to £56.5 billion. However, the fall in 2010 was entirely due to the suspension of BP’s dividend for the first three quarters of the year, according to figures compiled by Capita Registrars, which keeps the shareholder records of well over 1,000 quoted companies up to date.
Companies apart from BP increased their dividends by an average of 7.5% in 2010 as their shareholders received an early boost from the nascent economic recovery.
Even better was to come, for in 2011 UK-quoted companies paid £67.8 billion in dividends, more than they had ever handed to shareholders in any one year.
It is true that Capita’s data showed a heavy dependence on a few dividend payers. For instance, in 2010 just five very large companies – Shell, Vodafone, HSBC, GlaxoSmithKline and AstraZeneca – paid 38% of total dividends, while the top 15 companies paid 61% of all dividends.
So anyone investing in the largest companies would have received solid dividend payments notwithstanding the misfortune at BP, which in any case restored its dividend, albeit at a lower level, in the final quarter of 2010.
Spreading investments without increasing risk
However, there was plenty of scope for investors to spread their investments much more widely without significantly increasing risk because:
1 Fund managers invest disproportionately in the largest companies, leaving many medium-sized and smaller companies undervalued and offering higher yields.
2 The credit crunch left larger companies paying a disproportionate percentage of total dividends, a distortion that would be addressed as smaller companies came through the economic squeeze.
3 It is smaller, not larger, companies that bounce back soonest and furthest in the early period of recovery.
As Table 1.1 illustrates, smaller companies sensibly conserved cash and reduced debt in the immediate aftermath of the credit crunch. Soon, however, they were returning to paying dividends and taking up the slack caused by the fall in the BP dividend. Thus the top dividend payers were responsible for a declining proportion of the total paid.
Table 1.1 – Company size profile of UK dividend payers
More data from Capita reinforces this point: dividends from the medium-sized companies in the FTSE 250 Index rose 16.3% in 2010 while those from the FTSE 100 increased by only 6.8% (and it should be said that for investors to see their income rise by 6.8% in one not particularly promising year shows the potential benefits of dividend investing).
The trend continued. In particular, manufacturing companies that had struggled to remain competitive with cheaper production areas in Asia and Latin America rebuilt profits as the falling value of the pound on the foreign exchange markets gave UK exporters an edge.
Companies as diverse as ceramics specialist Cookson, which had not paid a dividend since the middle of 2008, and aviation services and newspaper distribution group John Menzies returned to the dividend lists early in 2011.
How is the size of dividend decided?
Technically the size of the dividend is decided by the shareholders in a vote at the Annual General Meeting (AGM). Interim dividends, decided by the board of directors, can be paid during the course of the year but the final dividend is not paid until approved by the AGM.
The agenda for the meeting may include a motion for shareholders to confirm any interim dividends already paid and to approve a final dividend recommended by the directors. Often, however, the dividend is not even mentioned on the agenda and shareholders are simply asked to approve the report and accounts, which includes details of the dividends.
It is clearly impossible to try to vote down the interim dividend and attempt to claw the money back from shareholders, some of whom will have subsequently sold their shares, although in theory the proposed final dividend could be rejected.
In reality, the board of directors decide on a figure for the interim and final dividends and this recommendation is nodded through by the shareholders.
As Table 1.2 covering AGMs held in 2011 shows, the dividend is almost invariably passed by a very large majority even where shareholders express their disquiet over, or openly revolt against, an issue such as directors’ pay.
Table 1.2 – Sample shareholder votes at company AGMs
In fact, for such a major matter there tends to be very little debate of any kind over the dividend. Although boards of directors meet every month, the dividend will be on the agenda only twice a year (or four times if there is a quarterly dividend) and then probably only as an item among the half-year or full-year results.
The finance director (sometimes called the chief financial officer) will draw up the results to be presented to the board and will suggest the size of dividend that is justified by the results. He or she will take into consideration:
the amount of profit that has been made in the relevant period
how much cash the company has in hand
the level of company debt, in particular whether any debts are due to be repaid
the amount of capital spending required in the current financial year
the extent to which income covers interest payments on debt
whether the company has a policy of maintaining or increasing the dividend each year.
Because
