Dividend risk

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Mitchell Fraser-Jones 10 February 2016 Est. reading: 6 min read

Last year was a year of capital risk, as our recent article “2015 – the year in review” highlighted. The discrepancy between the best performing stocks on the UK stock market and the worst, was very large indeed.

The UK equity market remains volatile in capital terms, but this year will increasingly become one of dividend risk, in our view. Many share prices in 2015 moved to discount the likelihood of dividend cuts, but very few of them have yet materialised. Over the coming months we expect this to change, so income investors will need to tread carefully.

Below, we have a clip of Neil discussing his view of the areas of the stock market that are most vulnerable to dividend cuts.

We’ve also done a bit of analysis on the parts of the market that look most susceptible to dividend cuts, which you can see in the chart below. We’ve looked at last year’s dividend per share payments from each constituent of the FTSE All Share index, and compared that to each stock’s current year earnings per share forecast, to get a sense of which companies may be over-distributing. We’ve then calculated a weighted average for each industry based on the current market capitalisation of each stock. A value greater than 100% suggests that last year’s dividends exceed the level of this year’s forecast earnings for that industry as a whole.

On this basis, some stocks in the basic materials, oil & gas and telecommunications industries are potentially over-distributing, with last year’s dividend commitments way in excess of this year’s earnings forecasts. This doesn’t mean that dividend cuts are inevitable this year – dividends are paid out of cash rather than earnings, and the cash flow dynamics of individual firms may be more attractive than earnings. Furthermore, companies can find cash through other means to service their dividends, such as through asset disposals or the debt market. Nevertheless, we would argue that a reading of above 100% indicates that stocks in these industries are paying unsustainable dividends on the basis of current earnings expectations, and dividend cuts from some stocks are therefore highly likely.

Chart showing the estimated dividend payout ratio, based on last year's dividend commitment as a percentage of current year earnings forecasts on a weighted average basis for all FTSE All Share index constituents

Reassuringly, as Neil mentions in the video the portfolios are not exposed to those areas, with the exception of telecommunications (the equity income fund has a position in BT but we are very confident that this business will continue to deliver attractive levels of dividend growth from here).

As such, we remain confident of delivering dividend growth in the year ahead, despite the obvious economic challenges and the prospect of widespread dividend disappointments elsewhere in the market. Indeed, as long term investors, our confidence in the outlook for dividend growth isn’t confined to 2016. The portfolio has been constructed with the aim of delivering consistent and dependable dividend growth for several years to come.

What are the risks?

  • The value of the fund and any income from it may go down as well as up, so you may get back less than you invested
  • Past performance cannot be relied upon as a guide to future performance
  • The ongoing charges figure is charged to capital, so the income of the fund may be higher but capital growth may be restricted or capital may be eroded
  • The fund may invest in other transferable securities, money market instruments, warrants, collective investment schemes and deposits – some of these security types could increase the fund′s volatility and increase the level of indirect charges to which the fund is exposed
  • The fund may invest in overseas securities and be exposed to currencies other than pound sterling – as a result, exchange rate movements may cause the sterling value of investments to decrease or increase
  • The fund may invest in unquoted securities, which may be less liquid and more difficult to value, because they are generally not publicly traded – the lack of an open market may also make it more difficult to establish fair value

Important information

Before investing, you should read the Key Investor Information Document (KIID) for the fund, and the Prospectus which, along with our terms and conditions, can be obtained from the downloads page or from our registered office. If you have a financial adviser, you should seek their advice before investing. Woodford Investment Management Ltd is not authorised to provide investment advice.

The Woodford Funds (Ireland) ICAV (the “Fund”) has appointed as Swiss Representative Oligo Swiss Fund Services SA, Av. Villamont 17, 1005 Lausanne, Switzerland. The Fund′s Swiss paying agent is Neue Helvetische Bank AG. All fund documentation including, Prospectus, Key Investor Information Documents, Instrument of Incorporation and financial reports may be obtained free of charge from the Swiss Representative in Lausanne. The place of performance and jurisdiction for all shares distributed in or from Switzerland is at the registered office of the Swiss Representative. Fund prices can be found at www.fundinfo.com.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

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