The yield on the FTSE 100 could be attractive at face value but that's not the whole story
Thursday 23 Jul 2020 Author: Russ Mould

An aggregation of analysts’ forecast for all of the FTSE 100’s members suggests that the index offers a dividend yield of 3.6% for 2020 and 4.4% for 2021.

Those figures may look alluring to income-hunters, especially as the Bank of England base rate looks firmly anchored at 0.1%, and the next move could even be down into negative territory, if some of the most recent rhetoric from Governor Andrew Bailey is taken at face value.

However, we began the year with the same analysts’ forecasts putting the FTSE 100 on a yield of 4.8% for 2020. Since then, dividend forecasts have been cut by a third and the index has fallen by a sixth, to add the insult of capital losses to the injury caused by lost income.

Before making any investment case for the UK on the basis of its yield investors must look at the source of the dividends and whether the forecasts are reliable.

THE NAMES THAT MATTER

The first thing to note for anyone buying UK equities for their income, either through an actively-managed or a passive fund, or via individual companies, is that just 10 stocks are forecast to generate 55% of the FTSE 100’s forecast £62 billion in dividend payments in 2020. Just 20 names are expected to provide 74% of the total.

Any investor needs to know these 20 names and have a view on their prospects, so they can assess whether the dividend forecasts are right or not, especially with BP (BP.) right at the top of the list – the oil major is seen by many as primed to follow that of Royal Dutch Shell (RSDB) and cut dividends.

This list inevitably shapes the sector mix of the UK’s dividend payments. Just five sectors are expected to generate three quarters of 2020’s £62 billion in shareholder distributions – consumer staples, oils, financials, miners and healthcare – not least because just three (industrials, healthcare and utilities) are expected to grow their payouts this year.

Two of those will only just manage it, if the analysts are right and the industrials rely heavily on a swift return to the dividend’s prior trajectory at BAE Systems (BA.) and a trio of packagers, Smurfit Kappa (SKG), DS Smith (SMDS) and Mondi (MNDI). Rarely did so much, beyond internet shopping, rest upon containerboard.

However, bad news about 2020’s dividend payments hardly represents a surprise after three months of headlines about cuts, suspensions, deferrals and outright cancellations.

The fact that 49 FTSE 100 firms have not cut but aggregate estimates for the total payout have plummeted only serves to highlight the importance of knowing the mix of payments by stock and sector.

Bouncing back

This takes us to the hoped-for recovery in 2021, when analysts currently predict total FTSE 100 payments will rebound to £75.5 billion, pretty much where they were in 2019.

The sector mix is particularly telling when it comes to the source of the anticipated increase. Two thirds of the forecast increase comes from just two sectors – financials and consumer discretionary, so in essence banks, retailers and insurers. Industrials also crop up again, but the rest offer little or nothing.

This could be a source of an upside surprise, such as if you think inflation is coming and oil and metal prices are primed to rise strongly as a result of a robust economic upturn.

Equally, it may be a source of concern, given the pressure the ‘Big Five’ FTSE 100 banks face from record-low interest rates and quantitative easing, which are squeezing net interest margins, not to mention rising loan impairments, political pressure to go out and lend, the dangers of a slow economic recovery and ongoing regulatory scrutiny.

That said, the banks entered 2020 with strong capital ratios and they could return to paying dividends quickly if the recessionary storm passes in short order.

In sum, the UK does on paper offer an enticing yield for 2021. But this assumes that dividend growth forecasts are correct and that key sectors like banks and retailers do the business. Just as is the case with the earnings mix, there looks to be plenty of risk, as well as opportunity.

This may be why investors are currently demanding that juicy-looking yield to compensate themselves for the possible dangers associated with holding FTSE 100 stocks.

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