Europe's cash-rich companies return to dividend culture


Fund managers explain how the recovery experienced by European dividends since 2008 has further to run, despite the recent high market volatility.

In the 1990s, for example, as irrational exuberance pushed markets skywards, dividends contributed just 2.4% or overall investor gains.

Schuessler adds the benefits of buying dividend growers also works in ‘growth' markets like Asia ex-Japan.

However, dividend investing does not come without problems. Ad van Tiggelen, senior investment specialist at ING Investment Management, says most companies with shares yielding over 5% "completely lack growth [and] conversely, companies which offer good growth have a low yield".

Fear of cuts

He puts utilities, whose shares yield up to 8% or almost double their bond yields, in the yield-but-no-growth basket.

"In the sector, the basic business model is sound as ever, but high capital investments, government interference and the discussion about nuclear energy have hit growth and caused fears of dividend cuts."

Meanwhile, growth-focused sectors benefiting from the cyclical recovery such as basic resources, IT, machinery, autos and luxury goods have grown dividends, but still typically yield only 1% to 3%.

"In this third year of the market rebound the cyclical stocks have become quite expensive, whilst the really high dividend yield stocks are cheap, but vulnerable," van Tiggelen says.

"We appear to have reached a point in the equity market cycle where investors should focus on stocks with modest valuations, average yields of 3% to 5%, and slow but sustainable growth." Healthcare, food, beverage and tobacco companies qualify, in van Tiggelen's view.

Another potential headwind for high dividend payers, Schuessler says, is an environment in which central banks are raising interest rates.

For this reason, he has about 5% exposure to emerging markets, and is not buying more yet.

"As long as there are inflation issues in emerging markets and central banks raising rates, it is a tough environment for dividend payers, which tend to be a bit bond-like. I would want to stop buying until central banks stop tightening and inflation is well under control.

"I believe you should have large developed markets weightings for dividend strategies - why take on emerging markets risk? And as a value investor I do not think EMs are screamingly cheap, either."

But Royce & Associates, a Legg Mason subsidiary, says looking for high dividend payers among large caps is just as important, and profitable.

Research on US stocks found dividend-paying smaller companies outperformed their non dividend paying rivals by 3.6% a year since 1993, and did so with less downside volatility.

Lauren Romeo (pictured), portfolio manager of the Legg Mason US Smaller Companies fund, says: "Dividends perform the same role as they do in the large-cap area, where the ‘total return' and ‘equity income' approaches are common."