Next month the banking sector will be able to start paying dividends to its shareholders again. However, before investors get too excited about renewed payouts from these erstwhile income favourites there is a potential sting in the tail.

The Prudential Regulation Authority will allow the banks to pay a dividend covering their 2020 financial year but dividends for 2021 can only be accrued and not doled out until the regulator has had time to reassess the situation in the summer.

That spells further disruption to the flow of dividends from this sector, which is very annoying to anyone dependent on income from their investments.

To help investors with alternative income options, Shares has run a screen of the UK market and identified some interesting high-yielding companies delivering strong returns and with robust balance sheets. Later in the article we suggest two of these stocks to buy. You can also read sine insights from fund managers on a global perspective for dividends.

DEEP SCARS FROM FINANCIAL CRISIS

The disruption to dividend payments from banks is a reminder that the deep scars left by the global financial crisis in 2007/2008 will lead authorities to keep the banks on a tight leash to protect their ability to absorb a deterioration in the credit markets and lend to consumers and businesses.

Manager of BMO UK High Income (BHI) Phil Webster, who deliberately avoids the banking space, sums it up: ‘There is an awful lot of focus on banks for income, but they operate in a commoditised industry, offer poor customer service and have “me too” business models. Yet again in this crisis their dividends have been cut.’

If investors can no longer rely on the banks for a smooth stream of dividends, they will have to start looking elsewhere.

Making this job more difficult is the fact that other previously reliable sectors for dividends, such as oil and gas, have also disappointed on the income front and seen pressure on their share prices both through the Covid-19 pandemic and in the years leading up to it.

‘You need to think about your total return,’ says Andrew Lister, manager of investment trust Aberdeen Emerging Markets (AEMC). ‘If you have an investment yielding 5% and it drops 5% in value, your total return is 0% and there’s really no point (in owning it).’

ALTERNATIVE INCOME PLAYS

The accompanying table shows UK-listed stocks with a net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) ratios of less than two times, a forecast return on equity in double digits and dividend yields of 4% or above (based on estimated dividends and the latest share price).

Essentially these are companies that do not have excessive amounts of debt relative to earnings, they are expected to make a decent return on the money they spend on their business, and they are forecast to pay out decent dividends.

Data-screening exercises are useful, but you also need to treat them with caution. The numbers in isolation won’t tell you everything about a business.

Looking at the list, mining companies and property-related stocks are well represented. While still reliant on volatile commodity prices, the mining firms do look better placed than their close counterparts in the oil and gas sector.

This is because they are likely to see demand increase rather than fall as a result of the transition away from fossil fuels given the importance of metals in areas like electric vehicle production.

While there are no banks on the list there are several other financial stocks which are not dogged by the same regulatory obstacles.

TECH AS A FUTURE SOURCE OF INCOME

We continue to see more fund managers looking at the technology sector for income. While dividend yields may be relatively low, many tech firms are expected to grow dividends by a large amount every year which makes them appealing over the long term for investors seeking income.

BMO’s Webster is one such income fund manager with significant exposure to the technology sector. He even invests in tech stocks that do not currently offer any yield, but justifies their inclusion in his portfolio as having the potential to generate capital growth in the short term and offer income potential longer term as they generate a lot of cash.

Both Apple and Microsoft pay dividends quarterly. Apple may only yield 0.6% based on forecasts for it to pay 85 cents worth of dividends in its current financial year. However, analysts believe it will pay just over $1 worth of dividends in 2023, which is twice as much as it paid in 2015 and illustrative of how fast dividends are growing.

Microsoft yields 1% but dividends are growing by about 7% or 8% a year, so significantly ahead of the rate of inflation.

Aberdeen Asian Income (AAIF) manager Yoojeong Oh notes that some technology enablers like Samsung and Taiwan Semiconductors pay dividends while even in more immature parts of the technology space like electric vehicles there are stocks offering income.

‘LG Chem is one of the top three companies for electric vehicle batteries and it recently increased its dividend,’ she says.

GOING GLOBAL FOR DIVIDENDS

The Link Asset Services UK Dividend Monitor report for the fourth quarter of 2020 made the stark prediction that UK dividends will not regain their pre-Covid levels until 2025 at the earliest.

Investors do not have to restrict themselves to UK shares in their hunt for income. Lots of global companies pay dividends too, and many fared better through the coronavirus crisis.

Martin Connaghan, deputy manager of global income investment trust Murray International (MYI), observes: ‘In China, third quarter (2020) dividends were up 3% on the previous year and in the US they fell just 3%.

‘There are different reasons why that’s the case. Because US firms had been buying back stocks at record levels all they really needed to do to maintain payouts was to stop buybacks. In Asia companies have lower gearing (borrowing).’

For many investors the best way to access these markets, given complications around currency and withholding taxes in certain territories, will be through funds and investment trusts. The table shows how global income investment trusts have performed on a total return basis over the last five years.

Connaghan adds: ‘We are not constrained by lines on a map. Regardless of where it happens to be domiciled, we are looking for a company to maintain and grow dividends.’

At the higher end of the risk spectrum is the approach taken by Aberdeen Emerging Markets’ Andrew Lister who says: ‘Income can be found in unusual places – often the most attractive income is found in areas that have not been scoured over by the masses. For example, frontier market bonds are very undervalued. In some cases, they have yields to maturity of over 9%.’

In a more general sense Lister thinks 2021 should be good for income as a theme, as many of the businesses which maintained dividends demonstrated their resilience through the pandemic and capital is set to move out of low-yielding fixed income investments and into dividend-paying equities.

TWO STOCKS TO BUY FOR INCOME

Berkeley (BKG) £44.59

Dividend yield: 4.5%

Housebuilder Berkeley (BKG) is arguably the highest quality operator in its sector. It has a strong balance sheet, with net cash of nearly £1 billion at the last count. It has also provided unrivalled clarity on the level of dividends shareholders can expect over the medium term.

It has committed to £280 million a year in shareholder returns up to 30 September 2025, with the next £140 million on track for payment by 31 March 2021.

Investors should look through any short-term bumps in the property market and focus on the longer-term need for more housing in the UK and a nation still intent on owning rather renting property.

Moneysupermarket.com (MONY) 266.8p

Dividend yield: 4.1%

The £594 million takeover of rival Goco by publishing group Future (FUTR) (14 Jan) leaves Moneysupermarket (MONY) as the only pure UK-listed price comparison business.

In the words of Shore Capital analyst Roddy Davidson, ‘this status should increase both its strategic and scarcity value in a sector that we expect to benefit from further structural growth’.

Crucially, from an income perspective the business generates lots of cash and has a strong balance sheet. It should benefit from a reopening of the economy as demand for its services in areas like credit cards and home services increases.

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