UK companies are paying out too much money to shareholders and instead failing to reinvest back into the company. That was the message last week from Bank of England chief economist Andy Haldane.
Haldane says companies are too beholden to shareholders rather than other company stakeholders. This, he says, is coupled with an increasingly short-termist view from investors, who are holding stocks for short periods.
“In particular, there have been concerns about the rising share of investors with excessively high discount rates and low holding periods – in other words, about ‘short-termism’,” says Haldane.
He highlights that a generation ago dividends accounted for around 10 per cent of profits, while today that figure is nearer 70 per cent.
However, fund managers argue many companies are still investing and, what’s more, it’s not so bad that they are paying out high dividends.
Miton Income fund manager Eric Mooresays: “The dream company makes a high return, at the end of the year they have got a lot of cash being generated, some will reward shareholders now and some will be used for future growth. It’s the job of management to decide what that balance should be. If they haven’t got good things to spend their money on then hand it over.”
He gives the example of tobacco firms, which are operating in a dwindling market. While they can work to boost the company’s market share, he says there is little point in investing in new production facilities or expanding staff as the market in general is dropping.
Haldane’s comments are a “huge generality”, says JP Morgan Claverhouse Investment Trust manager Will Meadon. “There is good capital expenditure and bad cap ex, some companies just don’t need more capex.”
Getting the balance right is key, agrees Neptune global income fund manager George Boyd-Bowman.
Instead of looking just to strong dividend payers, investors need to hunt out those firms that will be able to grow their earnings and dividends over time, particularly as the current dividend players look expensive at the moment.
“You need to be going up the risk curve a little bit to those companies that have perhaps reinvested in the business over the past five years, which has meant they have not grown their dividend,” he says.
He gives the example of UK company Devro, which makes sausage skins. It has spent the past few years reinvesting in the business, building new manufacturing facilities and has kept its dividend flat during that time. Once the company is benefiting from those new facilities he expects earnings to grow 50-60 per cent, and for dividends to grow at the same rate.
It comes down to good company-level analysis, says Boyd-Bowman.
Companies that do have to cut their dividend are not necessarily punished by shareholders for doing so, says Meadon. Tesco’s share price went up 15 per cent on the day it announced it was cutting its dividend, he says.
On the issue of shareholder supremacy, Moore says what is good for the company over the longer term is good for its other stakeholders, such as employees, suppliers and customers.
“If people are horrid to employees that might maximize profits in year one but it’s not a sustainable business. Likewise, if they rip-off customers they will just get away with that for a couple of years but they won’t be building a lasting business.”
Managers say Haldane’s assertion that company dividends have grown as a percentage of earnings is true but needs to be seen in the wider context of earnings, which have actually dropped over that time period.
Premier Asset Management Optimum Income fund manager Chris Wright says: “The reason such a high percentage of profits are being paid out is because profits have collapsed.
Moore adds: “Last year in aggregate for the FTSE 350 earnings went down 2 per cent but dividends went up 3 per cent, that means companies have been distributing more of their earnings over the past few years. Dividends have grown faster than earnings, because they have been anticipating a recovery in earnings that has not really happened.”
However, risk remains for investors holding companies that have been paying out steady, reliable dividends, which have been used as bond proxies in portfolios amid historically low interest rates, says Boyd-Bowman.
Investors are in for a shock when rate rises occur, he warns, as the valuations of companies considered bond proxies have reached very high levels, and a lot of investors are holding them.
“When we entered rate hiking last time in 2004 these bond proxy companies’ valuations on a price-to-earnings basis were on a 25 per cent discount to dividend-paying growth stocks. They are now at a 20-25 per cent premium,” he says.
However, there is concern as to where Haldane’s speech is leading.
Haldane ended his speech with a hint at more action, saying “it may be time for a more fundamental re-rooting of company law if we are to tackle these problems at source”.
Haldane is not the type of person to be “idly lobbing comments out”, says Moore.
He says: “This will be a thought-out piece on his position, it won’t be an off-the-cuff thing. There is quite a lot of thought behind this and it could be the beginning of some sort of movement and agenda, so we should pay attention to it.”