The news that BP is to reinstate its dividend is a welcome one, and investors with all but zero interest rates may well be flocking back to the stock.
Investors are being subjected to top end building society interest rates of around 3%, whereas inflation is currently outstripping that. It’s a very difficult position for investors as they can't really take that income because their capital will be eaten by the impact of inflation, so it’s easy to see why dividends are such an attractive proposition.
A dividend is paid by a company out of profits and investors have the benefit of the potential capital growth on the share price on top of that. It’s attractive, and investors are generally happy to strip out the dividends each year and allow the capital growth of that share price to take care of inflation – an interesting gamble perhaps.
BP’s dividend is slightly lower than it was before the Macondo crisis but currently yields 4.5%. (1) The UK market yields a dividend of around 3.2%.
There are plenty of other organisations who are paying dividends in excess of that, like GlaxoSmithKline at near 6%, National Grid at 6.5%, and Scottish and Southern Energy at 6.4%.
Fidelity produced some interesting statistics on dividends. Stocks that produce a yield have generally been good at inflation proofing. In the 70’s for example, the total return (the combined growth of stock and dividend) on US stocks was 5.9%, whereas the dividend was 4.2% of that.
Furthermore, dividend growth exceeded inflation by 2% over the last 85 years according to Bernstein.
At the moment, the FTSE Allshare is yielding 3.34% while the 10 year UK treasury yields 3.68%. There are 11 companies in the FTSE 100 which yield more than 5%, and more than 25% of the FTSE pays more than the 10 year UK treasury yield.
As inflation rises, earnings growth should typically grow, and as dividends rise in tandem with that earnings growth, anyone concerned about inflation should consider stocks or a fund that invests in such stocks.
For the investor who wants to leave the income to reinvest, there are clear benefits. Fidelity’s research shows that someone who had invested Â£10,000 in the FTSE All Share at the end of 1985 would have enjoyed almost Â£68,000 more if they had reinvested the income.
There are a range of funds that seek to maximise the yields on dividends whilst achieving capital growth by spreading the investment across a range of stocks. The normal spread is around 80 stocks, which gives the investor a balanced portfolio of investment.
As a run up to the ISA season, investors could use their ISA allowance of Â£10,200 per person and achieve tax free growth over the years of the investment. For those investors with more capital than that, they could also utilise other investment vehicles such as a unit trust or similar, where you are allowed a capital gains allowance of Â£10,100 per person per year.
So an investor who invests Â£50,000 and achieves 20% growth on that year would be able to access this completely tax free. And remember, that allowance is per person and per year.
In today’s very peculiar market, income seekers have to think well beyond the norm. It used to be that their property was a sure fire bet, but now occupancy, rent rates and falling prices have damaged that.
Structured products or guaranteed products tried to come to the rescue but many of these plans have caught investors out and indeed the fact that all the capital could be lost on some (Lehmans backed products for example) has meant a loss of appetite for such investment vehicles.
And so, for the income seeker or your pension pots looking for sustained growth, the safety of strong companies providing a dividend through profits added to the capital growth of their share price is proving more and more attractive.
For a fact sheet on the better income producing funds call Peter on 0845 230 9876, e-mail firstname.lastname@example.org or take a look at our website.
The value of shares and investments can go down as well as up
Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'