It’s a challenging time for investors, not least those in need of income generation. The coronavirus crisis continues to play out globally, with the UK hit worse than almost any other large economy. Covid-19’s scars are likely to be with us for a long time and the path to economic recovery remains uncertain.
However, we believe there are reasons for optimism on UK equities. Indeed, income investors, who may have previously overlooked the market, may want to reconsider their positions in light of some positive drivers. Let us tell you more.
Vaccines help vanquish dividend doubts
We are all familiar with the difficult dividend backdrop of the past year or so. We’ve witnessed dividend cuts, cancellations and regulatory intervention, as companies grappled with the financial impact of the pandemic. Combined with the long shadow cast by Brexit, these headwinds were enough to turn many investors away from the UK equities market.
But the tide could be turning. The UK’s rollout of the vaccine programme is progressing well, offering hope of an enduring route out of the pandemic. At the same time, the UK equities market is significantly under-owned. For example, global and European funds' holdings of UK equities are at their lowest for many years. This offers potential for upside performance when these portfolios are reweighted. Valuation is another significant draw. Even if you adjust for sector differences, UK equities are more attractively valued than their US and European peers.
The hallmarks of quality
The UK equities market also benefits from an abundance of good-quality companies that are still paying attractive dividends. In nearly all cases where dividends were vulnerable to cuts, they have now been rebased. We can, therefore, have more confidence in the UK market’s income level, with previously over-distributing companies returning to sensible pay-out ratios.
A company’s dividend is a useful touchstone for its health. From our perspective, we place great store in the simple premise; to consistently grow your dividends over the long term, you need to grow your earnings. Good-quality companies are best placed to do just that. As income investors, it’s important to remember that dividends provide a significant part of an investment’s total return. In addition, the yield acts as a backstop for a company’s valuation.
Quality companies are more likely to be able to pay dividends even when conditions are challenging.
A more optimistic outlook
In the aftermath of the pandemic, and in a world of low interest rates, high debt and pressure on corporate profits, the quality of a company will remain as important as ever. Quality companies are more likely to be able to pay dividends even when conditions are challenging.
From here, we expect to see the following waymarks.
- Investors will pay a premium for companies capable of delivering attractive and growing dividends.
- Those companies with strong balance sheets that can undertake merger and acquisition activity, or continue to invest in their businesses through the cycle should emerge in a stronger competitive position.
- Structural long-term earnings potential in a world of modest medium-term growth will continue to be prized.
- Therefore, companies with sustainable competitive advantages and pricing power should benefit disproportionately.
Final thoughts …
As we’ve highlighted, there are several positive drivers at play in the UK equities market. For income investors who may have disregarded it, we believe now could be a good time to reconsider investing in the UK.
At a time when quality counts, we maintain our disciplined and measured focus on financially strong, resilient companies that can thrive whatever the conditions. These businesses offer the potential to grow their earnings, and hence their dividends, over the long term.
Find out more about our UK equities investment capabilities here.