Cash payouts from shares have slumped in 2013, but it's not all been bad news from investors.
Why do individuals and fund managers buy shares? The simple answer is that by investing cash now, they hope to reap far more cash later down the line. The benefits of owning shares come in two ways:
- From capital gains: profits made by selling shares at higher prices than you paid for them.
- From dividends: regular cash payouts made to shareholders, usually half-yearly or quarterly.
What's quite remarkable is how crucial dividends are to your total return from shares. Studies show that up to nine-tenths (90%) of long-term returns come from reinvesting dividends into buying more shares.
In other words, dividends are very important to investors. Hence, when these payouts fall, investors should be concerned.
Dividends dive by a quarter
Now for the bad news: in the first quarter of this year, UK dividends were a quarter (25%) lower than in the first three months of 2012.
According to the latest quarterly Dividend Monitor report from Capita Registrars, dividends from UK-listed companies totalled £14.1 billion in January to March 2013. For the same period of 2012, this figure was £18.8 billion.
This is the steepest percentage drop in dividends since the middle of 2009, when markets were still reeling from the global financial crash. What's more, this is the lowest first-quarter payout for three years.
So, investors should be pretty worried, right? Not exactly, for these two key reasons:
1. Regular dividends are up more than 6%
The reason why investors enjoyed bumper dividends in the first quarter of last year was because of one-off 'special dividends' paid by two big businesses. These two giants -- mobile operator Vodafone and oil explorer Cairn Energy -- paid special dividends totalling £4.4 billion in the first quarter of 2012.
In addition, mega-bank HSBC paid its first-quarter dividend in December 2012 instead of January 2013, which knocked another £1.2 billion from 2013's total.
If we strip out special dividends to find the underlying trend for regular dividends, this shows healthy growth of 6.1% in 2013. Furthermore, for 2013 as a whole, Capita Registars is predicting total dividends of £80.5 billion (including £1.9 billion of special dividends). This is a tiny improvement on the £80.4 billion that investors received in dividends last year.
So things aren't as bad as they first appeared.
2. Share prices have soared
Another reason to be cheerful is that share prices have climbed strongly in the past 12 months. This has produced considerable capital gains for private investors, pension funds and insurance companies.
For instance, the blue-chip FTSE 100 index of elite British companies has risen by almost an eighth (11.7%) since a year ago, according to Google Finance. This 665-point increase in the 'Footsie' has added over £150 billion to the value of UK shares in just 12 months.
Hence, the decline in special dividends has easily been outstripped by capital gains produced by rising share prices. On the whole, shareholders have enjoyed a good run over the past year.
One danger of dividends
While millions of Brits have never owned even a single share in a company, the dividends and capital gains produced by shares have a major impact on the UK's personal wealth. This is because company shares form the foundation of our pension funds, investment plans and insurance policies. Therefore, when share prices rise, tens of millions of us benefit as Britain's overall wealth rises.
However, when you invest in dividend-paying shares to produce extra income, you take two risks. First, there is the risk of loss caused by falling share prices. Second, dividends are not guaranteed, so companies in crisis often cut or cancel these cash payouts to shareholders.
For instance, two major FTSE 100 firms have slashed their dividends this year. In February, insurer RSA Group (formerly Royal & SunAlliance) cut its final dividend by a third (33%). In March, fellow insurer Aviva followed suit, cutting its interim dividend to 9p from 16p, a reduction of nearly half (44%).
Diversify your dividends
In summary, the rate of growth of future dividends is uncertain, but is expected to reach 8.6% this year. However, this growth could falter when companies again start to invest heavily for growth. Likewise, individual dividends are at the mercy of boards of directors, to be cut or cancelled at will.
Therefore, if do invest in shares for extra income, then don't rely on a single or a few companies for regular cash payouts. By spreading your money around, you reduce your exposure to individual companies and sectors and thus also reduce your 'concentration risk'.
In plain English: don't put all your eggs in one basket and then watch that basket break!
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