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Investment: Equities

Dividends — the directors’ cut

11 March 2009

12:00 AM

11 March 2009

12:00 AM

Dividends — the directors’ cut

At least the savers whose interest rates have been squeezed still have their money in the bank. Shareholders, by contrast, are seeing their dividends slashed after also suffering substantial share price falls — and there is no compensation scheme to cover their lost capital.

That is a risk of equity investment but there was a time when cutting the dividend was the last thing a company did; now it’s top of the agenda as soon as business gets tough. When ICI reduced its payment to shareholders during the 1980 recession, its directors were pilloried and its share price plunged; now, freezing the dividend, cutting it — or even totally abolishing it — is part of the macho, hair-shirt management style of directors desperate to show that they are doing something. In comes a new board, out goes the shareholders’ payment.

The number of companies cutting their dividends rose six-fold last year but with 2008 results now being announced, dividend falls and freezes are outnumbering increases. Last week Psion and Jardine Lloyd Thomson pegged their payments while property group Segro and insurer Aviva joined the ranks of the dividend cutters. ITV, Old Mutual, Manganese Bronze and Premier Foods told investors to expect nothing at all. Bovis joined fellow housebuilders this week in saying there will be no cheques in the post. Royal Bank of Scotland and Lloyds have followed Barclays in abolishing dividends — even though the latter declared a £6 billion profit.

The City fears that so-called blue-chips from BT to Marks & Spencer will be next to tell shareholders to take the strain, and there are worries the life assurance firms will cut dividends to boost their balance sheets now that their investment portfolios have fallen. Has it dawned on the life company directors that investments have fallen because companies are cutting dividends?

Some companies are seeking to conserve cash and others to preserve capital, but there is also a herd instinct in matters of dividend policy. Time was when companies would avoid a cut at all costs, if only to cover up financial weakness. Once one board cuts, however, others follow; and before long it’s the norm. But it’s no good reducing dividends to make the business more profitable (by using the cash to reduce debt, for example) if the owners of the company do not benefit from the enhanced earnings.

Inflation is falling but it is not yet negative; either directly or through pensions, many people rely on income from shares to live. Even merely freezing that dividend income causes them pain. And while bank savers can reluctantly withdraw their deposits to supplement their cash flow, shareholders would have to sell equities at rock-bottom prices that produce very little capital. Indeed, the current fashion for rights issues means equity investors are likely to be asked to send their companies a cheque instead of receiving one. But without the prospect of earning a return on the new investment, what incentive is there to buy additional shares?

Boards can blame stock markets for reducing the prices of their companies (though they always take personal credit when share prices rise), but cuts in dividends are at the discretion of directors. Businesses used to treat dividends like with-profits policies, holding back earnings in the good times to create a reserve so payments could be maintained when trading turned down. There is even an argument for increasing the dividend to compensate investors when markets drive the share price down.

Now, however, shareholders find they received an average of just 40 per cent of post-tax profits when earnings were rising — but must take a cut when recession arrives. Whatever happened to the reserve for rainy days?

The most spurious excuse for cutting a dividend is that the fall in the shares’ price has left them yielding more than the market, more than rivals or more than historic expectations. To cut the income of shareholders because they have already had half their capital wiped out is to add insult to injury. Indeed, for the investor who bought at twice today’s price, the yield has not risen at all. Boards that cut payments to keep them in line with market yields are proving they have no interest in the loyal shareholders who have stuck with the company; directors merely want dividends set at the level necessary to attract new investors.

Hedge funds and speculators dip in and out of shares, seeking capital gains. Surely companies should want long-term investors who hold for the income?

A glance at the newspaper share price pages will suggest that equities are yielding almost 5 per cent — more than stock markets usually return and much, much more than money in the bank now earns. But don’t believe those calculations: they are applying last year’s historic dividends to today’s depleted share prices. As this year’s results season continues to unfold, we will see more and more companies join the trend to cut dividends, thus bringing down the quoted yields. Before directors cut, they should not only remember who owns their company — they should also remember why those investors own it.

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