Dividend Cuts Highlight Need To Rethink Equity Income Strategies

By First Sentier Investors | More Articles by First Sentier Investors

The cuts to dividends revealed in the ASX reporting season provide a reminder that generating income from equities requires a long-term outlook, according to First Sentier Investors.

In an investor update, Rudi Minbatiwala, Head of Equity Income, noted that the total amount of dividends paid out by ASX-listed companies fell by 27% (between FY19 and FY20), as approximately 70% of companies reduced their dividends or paid none at all (1).

“The companies that cut dividends weren’t exclusively the ones who suffered losses over the reporting period; some made the decision to pre-emptively shore up their balance sheets. COVID-19 has hit different industries in different ways, and reinforced the notion that returning cash to investors is only appropriate when companies have some level of comfort about the future.

“In the recently completed FY20 earnings season, we saw companies cut dividends based on a range of factors. While companies such as Ramsay Healthcare actually saw a drop in revenue due to elective surgery cuts, other companies, like James Hardie, performed well but made a decision to strengthen their balance sheet for the future,” he said.

Mr Minbatiwala said that while the circumstances were different for these companies, the theme was the same: a prudent approach to protecting capital in a time of uncertainty.

“It’s difficult to criticise Boards that make such decisions for the short-term, as they are clearly looking to the medium- and long-term health of the company.”

Mr Minbatiwala said these developments underline the need for a more holistic approach to equity income.

“Dividend yields can be volatile and don’t tell the whole story of a company’s value; a more sustainable approach views income through the lens of total returns. We take a more holistic view of the investment options available to us, considering total returns and long term earnings growth, in addition to dividend income.

“This approach provides the flexibility to be invested in the right stocks, at the right time, at the right price during different market conditions.”

While long-term, sustainable income is desirable, Mr Minbatiwala concedes that many people also need income now. To achieve this, his strategy uses options to provide for short term income needs.

“In our experience, a buy-write strategy delivers smoother returns through the market cycle. In addition to the two traditional streams of income generated from dividends and franking credits, options can exploit share price volatility to generate a third stream of income called option premium income.

“In a period where investors have been reminded that dividend yields are not as reliable as one might hope, we have found this diversified approach is an effective approach to providing income from equities,” he said.