Just a handful of sectors have driven overall market dividend growth in the last seven years, according to Russell Hogan, managing partner of the Edinburgh-based Dundas Partners.
Hogan, on a whirlwind tour of NZ last week, said total share dividends paid out by the world’s biggest companies jumped from US$1 trillion in 2012 to about US$1.3 trillion at the latest count.
“But all of that extra $300 billion dividends has come from just five sectors,” he said, of which IT has been the most notable mover.
“In 2012 IT companies represented about 5 per cent of dividend payouts – and that’s grown to more than 10 per cent today,” Hogan said.
Dundas is currently overweight IT by more than 12 per cent in its concentrated global equities portfolio that also has a significant bent (7.5 per cent above benchmark) to healthcare stocks.
But Hogan said whatever sector biases there are in the Dundas portfolio have emerged out of its search for companies likely to offer future sustainable dividend growth rather than from any thematic view.
Dundas primarily targets companies it identifies as likely to deliver long term ‘dividend growth’ – a metric, he said, that few investors pay much attention to despite its power in generating returns.
In a recent presentation, Hogan cited a 2016 MSCI study carried out on behalf of the Norwegian Ministry of Finance that found ‘dividend growth’ represented 60 per cent or more of total equity returns over 10- and 20-year periods. During the same 10- and 20-year periods, ‘dividend yield’ equaled 19 and 29 per cent of total returns, respectively.
“If you hold securities over the short term, say, for a year, valuation changes matter a lot. Over the period analysed, such changes contributed more than half of the returns, on average, for equities held up to months,” the MSCI study found. “But over much longer periods, up to 20 years, the picture changes dramatically. In the long run, dividend yield and dividend growth contributed 93 per cent of returns, compared with roughly 7 per cent for changes in valuation.”
The distinction between dividend growth and yield was important for long-term investors, Hogan said.
Yield measures a point-in-time corporate dividend ratio that may not be sustainable over the longer-term – or “income now”, he said; by contrast, dividend growth reflects the improving health of the underlying business over time.
The Dundas portfolio, in fact, is behind the average market dividend yield rate by about 70 basis points but is more than double the MSCI global equity index as measured by dividend growth.
As at March 31 this year, the Dundas global equity fund reported dividend growth of 12.7 per cent against the MSCI average of 5.3 per cent.
Hogan said about 90 per cent of the Dundas portfolio consisted of dividend-paying companies with the remaining 10 per cent defined as “incubator” firms that show potential to generate dividends in the near future.
Current Dundas holdings in the ‘incubator’ camp include digital payments firm Paypal and Google parent, Alphabet.
“We look at company financials and ask do they have the ability to pay dividends and take a view on whether the board will at some point make a commitment to do that,” he said.
For example, Dundas bought Apple stock about seven years ago in the expectation that the board would eventually change tack and start paying dividends.
“We thought they would and they did,” Hogan said.
He said dividends provide investors with one of the few forward-looking indicators in an era where companies face tight constraints about what can be published.
“Dividends tell us something about the past, but also something about a company’s future,” Hogan said. “Boards are looking at internal information like order books and big tenders they might expect to win. So when they declare dividends it gives a signal about the business’ future prospects.”
And unlike share buybacks, which have become increasingly popular in recent years, dividends reflect a strong “covenant between shareholders and the board”, he said.
While both dividends and buybacks see cash flowing back to shareholders, Hogan said the latter approach can be problematic if it is funded by too much debt or used to puff up earnings-per-share (EPS) numbers.
EPS is commonly used as a baseline measure for board and management remuneration, which can create a conflict of interest around buybacks.
“You can improve your EPS in two ways: by increasing earnings or reducing the number of shares,” he said. “As investors we have to look at the underlying business behind the headline numbers. And sometimes large share buybacks are used to mask lower-growth businesses.”
Dundas uses another indicator – the ‘pay-out ratio’ – to analyse whether companies are reinvesting in future growth. By that yardstick, the Dundas portfolio has a slightly lower pay-out ratio (39 per cent) than the broader MSCI global shares index (44 per cent), which indicates the fund’s underlying companies are on average investing more in growth than their peers.
Both the Australian and NZ stock markets have pay-out ratios hovering around 70 per cent, according to Bloomberg and MSCI data.
Dundas was founded in 2010 by a core team including former head of Walter Scott Partners, Alan McFarlane. The Dundas global equity fund is marketed in Australasia under the Apostle multi-affiliate brand that also includes Artesian Capital, Windham Capital, M H Carnegie & Co and Kayne Anderson Capital Advisors.
In NZ, Dundas has a third-party distribution agreement with Heathcote Investment Partners.