Dividends are not unique to this country, but they are a notable feature of the UK stock market that continues to make it attractive to many income-seeking investors.
Sexy? No. Racy? No, no, no – especially when compared against tearaway US tech stocks that can provide patient investors with juicy long-term returns as long as they are prepared to participate in the stock market’s extreme version of snakes and ladders (sharp falls and steep climbs).
But like a cup of hot chocolate late at night, dividends provide comfort – a regular stream of financial return – to counter the volatility of equity investing.
Of course, a lethargic UK economy, and for that matter a benign global economy, are not ideal for generating company dividends.
On the upside, UK Gross Domestic Product figures released a few days ago did confirm 0.6 per cent growth during the second quarter of this year.
Investors must also be aware that Labour could tax more onerously the dividend income they receive outside their tax-friendly pensions and Individual Savings Accounts.
There are plenty of big-name UK companies that are worth investing in now as they are undervalued by as much as 20 per cent compared to overseas rivals
Yet, with the recent cut in interest rates making cash less compelling, the case for dividends remains robust.
City experts say UK-listed companies are still likely to grow their dividends by an inflation beating 3.8 per cent this year. And with the UK stock market still some 20 per cent undervalued compared to other mainstream equity markets, this dividend growth could be accompanied by strong share price gains. A rather enticing combination.
Jason Hollands, managing director of investment platform Bestinvest, says the UK equity market has long been the ‘premier market for dividend fans’ – and remains so today. He adds: ‘It is currently the highest yielding developed market globally and UK shares are attractively valued too.’
Currently, both the FTSE 100 (an index comprising the 100 largest companies listed in the UK) and the wider FTSE All-Share offer investors an annual dividend yield of around 3.6 per cent.
This figure shows the amount of dividends that companies pay out in percentage terms, relative to their share price – and is widely used when comparing divis to other income-generating assets such as bonds and cash.
But there are many solid household UK-listed companies whose shares are currently providing investors with dividend yields in excess of 3.6 per cent – in a few cases up to 10 per cent.
A number of professional investors believe some of these high yielding shares (not all) represent exciting investment opportunities. Not just in terms of the income potential they have, but the fact that their share prices are undervalued and could bounce back.
Among them is Ian Lance, a partner of investment house Redwheel and joint manager of Temple Bar – an investment trust which specialises in hunting down attractive yielding shares which the managers believe the market is undervaluing.
Lance points to research conducted by academics at Cambridge University which supports the case for investing in high-yielding UK shares.
The analysis, based on data from 1900 to the end of 2022, shows that the average annual return from high-yielding UK shares over this extended period was 10.4 per cent, compared to a market return of 9.1 per cent. Plenty of other studies have shown that most of the total return from UK equities comes from dividends, especially when they are reinvested.
Says Lance: ‘To understand why a high-dividend-yield investment strategy might work, you need to be aware that when you buy a share in a company, there are essentially three sources of return. These are the dividend yield, future dividend growth and any increase in the company’s market valuation.’
He adds: ‘So, if you are looking for a seven per cent annual return and you buy a stock yielding six per cent, you only need dividend growth or an increase in the valuation of one per cent – a pretty low bar. But if you buy a share with a one per cent yield, you need the other 6 per cent to come from dividend growth or an improvement in the company’s market valuation. That’s a higher bar.’
Although he admits that a focus on high-yielding UK shares is not without its traps – sometimes a high-yielding share indicates that a dividend cut is around the corner – he says now is not a bad time to be looking at such shares.
‘The UK stock market has been out of favour for a while,’ he explains. ‘This means there are some high-dividend yields available from companies which are fundamentally sound and underpinned by good profits and sustainable dividends.’
So which companies and income-focused investment trusts should now be on your investment radar? Last week, we asked a panel of investment experts to identify the high yielding UK companies that potentially could prove shrewd investments. They are not recommendations and should only be bought as part of a balanced investment portfolio.
By ‘high’, we mean yields in excess of 3.6 per cent.
All the dividend yields quoted are from investment platform Hargreaves Lansdown and are calculated based on a company’s last reported annual dividend (excluding any special dividends) and the latest share price.
Big names you can still bank on
Shares in banks HSBC and NatWest currently provide above-market annual dividend yields of 7.5 and 4.9 per cent.
Richard Hunter, head of markets at investment platform Interactive Investor, says that a company’s dividend yield should not be taken in isolation as a reason to invest. ‘A seemingly healthy dividend yield can be the result of a falling share price and a company potentially in trouble,’ he warns.
Shares in HSBC currently provide above-market annual dividend yields of 7.5 per cent
But he is won over by HSBC’s dividend yield because the company overcomes key hurdles.
Those hurdles are: sufficient current earnings to support dividend payments to shareholders (rather than dipping into reserves).
And an acceptable share price performance (up 12 per cent over the past year).
Thirdly, a positive market consensus on its prospects (in other words, a buy rather than a sell).
NatWest is currently the biggest holding in Temple Bar, the £780 million stock market listed investment that Redwheel’s Lance runs alongside Nick Purves.
Over the past year, its shares are up 55 per cent. Temple Bar also has a stake in Barclays – a top 10 holding. Its dividend yield of 3.6 per cent is in line with the stock market.
Russ Mould, investment director at investment platform AJ Bell, says the ‘robust cash flows’ being generated by insurer Phoenix ‘may persuade’ investors to look at it. The FTSE 100 company has a dividend yield of 9.5 per cent and has a good recent record of growing its dividends – 52.65p in the last financial year, compared to 50.8p for the year to the end of 2022. Over the past year, its shares have risen by 10 per cent.
Other high-yielding insurance shares include Legal & General (9 per cent) and Aviva (6.7 per cent).
‘Investors were disappointed with the decision of new L&G boss Antonio Simoes to target two per cent annual dividend growth over the next four years,’ says Mould. ‘But it has plenty of regulatory capital on its balance sheet [reassuring for investors] and offers a fat yield.’ Over the past year, its shares have risen six per cent.
Matt Britzman, senior equity analyst at Hargreaves Lansdown, says Aviva ‘brings insurance, wealth management and retirement products all under one roof’.
The 6.7 per cent dividend yield is an ‘obvious reason’ for income investors to consider it a sound investment, he adds. Like Legal & General, Britzman likes the fact it has a strong capital base. He also says the company is benefiting from the strong rise in motor and home insurance premiums. Plus the revenues it is generating in the bulk annuities market as companies protect themselves from the cost of running expensive defined benefit pension schemes for employees and former workers.
Over the past year, Aviva’s shares have risen 31 per cent while its declared interim dividend for the current financial year was seven per cent higher than last year.
Tobacco stocks and oil still offer good value
Although the likes of BAT, BP, Imperial Brands and Shell are not every investor’s cup of tea – and in the case of the oil companies not particularly liked by Labour’s green brigade – they offer attractive dividend yields. The respective yields are 8.3, 5.3, 5.9 and 3.8 per cent.
Despite campaigns to end smoking and falling market sales, tobacco giant BAT offers a solid share price performance (up 10 per cent) over the past year
Interactive Investor’s Hunter says tobacco giant BAT clears the same hurdles as HSBC (see earlier). That is, a compelling yield, more than enough earnings to justify the dividends it is paying shareholders (£1.18 in the first half of this year), solid share price performance over the past year (up 10 per cent) and a market that considers its shares a ‘buy’.
AJ Bell’s Mould says BAT and Imperial Brands continue to generate lots of cash despite declining cigarette market sales – thereby justifying steadily rising dividend payments to shareholders.
Meanwhile, BP and Shell are both top five holdings in Temple Bar on the basis of their dividend yields and robust businesses.
Let experts pick your income-focused trusts
For investors who prefer to leave the stock picking to experts, there are many stock market-listed investment trusts that offer shareholders an above average market dividend yield.
Among them are Murray Income, yielding 4.4 per cent, a favourite of Bestinvest’s Hollands. He says: ‘This trust has grown its dividend for the past 50 years and is invested primarily in big blue chip companies such as AstraZeneca, Unilever and the London Stock Exchange.’
AstraZeneca is a favourite of stock experts when suggesting market-listed investment trusts that offer shareholders an above average market dividend yield
Dividends are paid quarterly and over the past year, it has delivered a total return for shareholders of 15 per cent. Other UK equity income trusts with attractive yields include JPMorgan Claverhouse (4.7 per cent) and Merchants (4.8 per cent).
Simon Gergel, manager of £870million Merchants, holds a number of the stocks that Wealth’s experts have identified as potentially attractive – BAT, BP and Shell are top 10 holdings.
He says: ‘Although we set out to offer our shareholders a market beating yield, we don’t get fixated by the yield a company offers.
‘What I want is to buy companies with a strong degree of confidence that they will make an attractive combination of share price gain and income for the trust.’
He says Inchcape, an automotive distributor, retailer and service specialist, is typical of the companies he likes Merchants to hold.
He explains: ‘It’s a great business with a strong cash flow, a good dividend yield (four per cent) and is gently tickling up its dividend payments to shareholders. Although the share price is up 16 per cent over the past year, the shares still look cheap.’
Ryan Hughes, investments expert at AJ Bell, likes City of London, which has a dividend yield of 4.7 per cent. He says: ‘This trust has been an income seeker’s favourite for many years in light of a remarkable unbroken record of dividend growth going back 58 years. What I also like about the trust is that its annual charges are great value for money at 0.37 per cent.’
Plenty of income options to chew over while drinking that late night hot chocolate.