The Dividend Investor. Rodney Hobson
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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 these are all financial matters, the view of the finance director on what the level of dividend should be is of considerable importance and he or she will almost certainly have a figure in mind. This proposed dividend will usually be discussed with the chief executive, and possibly the chairperson, ahead of the board meeting to see if there is a broad agreement among these key directors.
The finance director’s proposal will be put to the board meeting and if there is no alternative suggestion then that is that. If the chief executive feels strongly that a different amount is appropriate then a second proposal will be put to the meeting for debate and a vote will be taken on the rival amounts. In the event of a tie, the chairperson’s casting vote will decide.
Very often there is no debate, and any discussion would almost always be reasonable and courteous, however good or bad the results. A heated row is highly unlikely and would happen only if the results are disastrous and the dividend has to be reduced or suspended.
In the end, most dividends are agreed unanimously. The scope for manoeuvre is limited by the parameters set by the results.
One item that may be discussed is whether to rebalance the dividend. Sometimes a company may be cautious after the first half and hold down the interim dividend; if all goes well the final dividend can be raised. Thus the final dividend may become disproportionately large compared to the interim. In such a case the board may debate raising the interim dividend by a larger amount than the final to bring the ratio between the two dividends into line with the generally accepted norm of 33:67.
Case study: Wynnstay
According to Paul Roberts, the finance director of Wynnstay, the most important point in setting the dividend is to maintain balance.
His company, supplying agricultural products and pet foods, was floated on the Alterntive Invesrtment Market (AIM) in 2004 after two years on Ofex, the third tier trading system now called Plus. By August 2011 it had a stock market capitalisation of £54.5 million.
Initially it paid just one, final, dividend a year to keep down costs but introduced an interim dividend in 2006, roughly in the ratio of 1:2.
As the man in charge of the coffers, Paul is conscious of the need to retain sufficient cash to develop the business while providing some rewards for shareholders.
He says:
We have had a long term strategy, both prior to flotation and since, to give a clear view to the markets what our dividend policy would be. Because we are a small cap company