How positive earnings and dividend momentum underpin FTSE 100’s gains

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Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.

At the time of writing the FTSE 100 sits just above the 7,300 mark, a fraction below the new record-highs north of 7,400 reached earlier in the month.

One reason for the fresh gains may be positive momentum in corporate earnings and dividend forecasts.

Ultimately it is profits and cash flows that dictate long-term returns from securities, either via capital gains or dividends, so this is an encouraging trend.

It does at least suggest there is some substance to the fresh gains in the UK stock market as relying on politicians, economists or central bankers leaves investors trying to predict the thoroughly unpredictable.

These – no doubt well-meaning – individuals do not have a crystal ball so they have no more idea of what is going to happen than you or this column.

As such, investors would do well to remember legendary US investor Warren Buffett’s maxim that: “If you mix your politics with your investment decisions, you’re making a big mistake.”

Equally, investors still need to stress-test the quality as well as the quantity of the earnings and dividend upgrades we have seen for the FTSE 100, to make sure the forecasts prove sufficiently reliable to keep supporting further advances in the index.

In sum, Mining, Banks and Oil remain the key sectors when it comes to earnings and dividends.

So metals prices, interest rate expectations and oil price are likely to be the key tone-setters over the rest of the year and beyond and an investor will need to take a view on all of these when assessing the UK market, particularly if they are looking to take exposure through a passive tracker or exchange-traded fund (ETF), rather than via an actively-managed collective or individual picks.

Numbers game

AJ Bell has carried out its quarterly test of the consensus forecasts for all of the members of the FTSE 100 and then aggregated those figures to provide a total for the index overall.

  • The bad news is that profits and dividends for 2016 came in lower than anticipated, as banks (owing to more extraordinary charges for conduct, litigation and payment protection insurance), media and retailers generally disappointed, relative to expectations. This continued a run of downgrades that stretches back to 2014.
  • The good news is that profit and dividend forecasts for 2017 moved higher for the third quarter in a row. Analysts now expect total pre-tax profits from the FTSE 100 of £197 billion for 2017, and dividends (excluding special dividends) of £80.4 billion, compared to £171 billion and £75.4 billion respectively nine months ago.

Forecasts for FTSE 100 aggregate earnings in 2017 continue to rise

Forecasts for FTSE 100 aggregate earnings in 2017 continue to rise

Source: Digital Look, consensus analysts’ estimates

  • In addition, initial forecasts for 2018 call for another increase in profits to £215 billion and in dividends to £87 billion.

Forecasts for FTSE 100 aggregate dividends in 2017 continue to rise

Forecasts for FTSE 100 aggregate earnings in 2017 continue to rise

Source: Digital Look, consensus analysts’ estimates

Admittedly these forecasts are not guaranteed to be correct but at least the trend is currently the investors’ friend, especially the dividend figures, which imply a 2017 dividend yield from the whole index of 4.1% and a 2018 one of 4.4%.

Quality test

With the UK 10-year Gilt offering a yield of 1.3% at the time of writing, the FTSE 100 is offering a premium yield of 280 basis points (or 2.8%) for 2017, based on the forecasts above.

Investors must remember that stocks bring greater capital risks than bonds, at least in theory, so there is always a chance that a share price fall, or tumble in the broader index, wipes out the yield premium if an investor finds themselves then obliged to sell at an inconvenient moment.

It is also worth considering the source of the dividends. Banks, life insurers and oils are forecast to provide 46% of the £80.4 billion aggregate payment from the FTSE 100 in 2017.

Financials and oils are expected to be the dominant dividend payers in 2017

Percentage of dividends 2018 E 2017 E
Oil & Gas 24% 23%
Financials 22% 22%
Consumer Staples 12% 11%
Health Care 10% 9%
Consumer Discretionary 9% 8%
Industrial goods & services 7% 7%
Telecoms 7% 6%
Utilities 5% 5%
Mining 4% 7%
Real estate 1% 1%
Technology 0% 0%

Source: Digital Look, consensus analysts’ estimates

Dividend payments are expected to rise by £9.5 billion in total in 2017. A third of that growth is due to come from miners (notably Glencore, BHP Billiton, Anglo American and Rio Tinto), while banks and insurers are forecast to come from banks and insurers (notably Lloyds) and 15% from the oils (although that is a function of dollar gains against the pound rather than actual payment increases from BP or Shell).

These are the key sectors to watch when it comes to dividends in the year ahead (excluding special dividends):

Miners, financials and oils are the key to dividend growth estimates for 2017

Percentage of dividend growth 2017 E 2018 E
Mining 33% 12%
Financials 26% 49%
Oil & Gas 15% 4%
Consumer Staples 9% 11%
Industrial goods & services 7% 5%
Health Care 4% 3%
Consumer Discretionary 3% 12%
Telecoms 1% 4%
Utilities 1% 2%
Real estate 0% 0%
Technology 0% 0%

Source: Digital Look, consensus analysts’ estimates

On the face of it, dividend cover at the miners is good at 2.5 times, but that cover will shrink if metal prices roll over. Banks and insurers look sound enough at 1.9 times and 2.0 times – although the banks need to avoid another rash of fines and conduct charges – while the oils are one times earnings cover could do with an improvement in the oil price to provide long-term comfort.

Profit pointers

The same sectors dominate when it comes to earnings forecasts. Banks, insurers, mining and oils are expected to generate 51% of aggregate FTSE 100 pre-tax income in 2017:

Miners, financials and oils are FTSE 100’s leading profit generators, according to analysts’ forecasts

Percentage of profits 2017 E 2018 E
Financials 23% 25%
Mining 15% 12%
Consumer Staples 13% 13%
Oil & Gas 13% 15%
Consumer Discretionary 10% 10%
Health Care 9% 9%
Industrial goods & services 8% 8%
Utilities 3% 3%
Telecoms 3% 3%
Real estate 1% 1%
Technology 0% 0%

Source: Digital Look, consensus analysts’ estimates

This quartet’s importance is made all the clearer by their forecast 77% contribution to profit growth estimates for 2017.

Miners, financials and oils are FTSE 100’s leading earnings growth drivers, according to analysts’ forecasts

Percentage of profits growth 2017 E 2018 E
Mining 27% -24%
Oil & Gas 24% 31%
Financials 24% 47%
Health Care 12% 7%
Consumer Staples 6% 11%
Consumer Discretionary 3% 12%
Industrial goods & services 3% 8%
Telecoms 1% 5%
Technology 0% 1%
Real estate 0% 0%
Utilities -1% 2%

Source: Digital Look, consensus analysts’ estimates

It is fair say this column views such as mix as decent in quantity but low in quality. All four sectors remain treacherously difficult to predict and a slowdown in the UK economy and housing market would quickly trip up banks, disappointment from President Trump or China could derail the recovery in metals prices and oil is already looking soggy, owing to rampant US production.

Equally, the banks could continue to benefit from a gradual rise in interest rates in the US, China is unlikely to disappoint in a year when the nineteenth Communist Party Congress is due to take place and OPEC is currently sticking to production cuts.

These sectors can cut both ways.

The UK’s reliance on oil, miners and banks hurt its performance in 2014 and 2015 and helped it in 2016. They, along with the pound, are likely to set the tone for some time to come.

Russ Mould, AJ Bell Investment Director


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Written by:
Russ Mould

Russ Mould has 28 years' experience of the capital markets. He started at Scottish Equitable in 1991 as a fund manager and in 1993 he joined SG Warburg, now part of UBS investment bank, where he worked as equity analyst covering the technology sector for 12 years. Russ joined Shares in November 2005 as technology correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media by AJ Bell Group, he was appointed AJ Bell’s Investment Director in summer 2013.