Global dividends: a dependable source of return in uncertain times

With inflation on the rise and interest rates set to increase from historic lows, there’s no doubt that investors are considering their options and working out how best to navigate this changing environment.

Bonds face challenges in a rising rate environment – in the year to date (to 2 May, 2022), the Bloomberg Global Aggregate Index, an index of investment-grade bonds, was down 12 per cent in USD terms.  Risk assets like equities also face challenges, as rising rates may lower what investors are willing to pay for potential future cashflows. Holding cash may not be ideal because inflation will erode its value in real terms. However, one sweet spot for the current environment may be found in dividend-paying equities.

The good news is that we appear to be entering a favourable period for companies that can grow and pay dividends. During periods of high inflation – greater than 5 per cent – companies that pay high dividends tend to do better than the broader equity market. This is according to research from Goldman Sachs, with a data set for the S&P 500 that goes back to 1940, which suggests that a focus on dividends could help mitigate inflation.

To further bolster this, in the high-inflation period of the 1970s, the S&P 500 delivered total returns of 77 per cent in US dollar terms. About three quarters of the total returns were attributable to dividends and dividends reinvested. Looking at the last 20 years, dividends and dividends reinvested have made up about half of the total returns of the MSCI AC World Index – that is, half of the 315 per cent in total returns (in the 20 years ending 30 April 2022). Dividends are a very important component of total returns even in a moderate- to low-inflationary environment, but are likely to be an even more important component as inflationary pressures mount.

So, what about the current dividend environment? Dividends are currently in abundance and the outlook for dividend growth appears positive. In the 12 months ending 31 March 2022, the companies in the MSCI AC World index paid out almost US$1.3 trillion in dividends. The dividends paid by global companies in the index in 2021 were 17 per cent higher than 2020. The global economic recovery has supported both an earnings recovery and a dividend recovery from the lows of the 2020 Covid-19 recession.

Even in 2020, amidst the economic and earnings headwinds, companies in the index have paid out over US$1 trillion in dividends. This underscores the resilience of dividends and their dependability as a source of return across the market cycle. Looking ahead, company earnings are expected to grow around 10 per cent in 2022 and we should expect to see a similar growth in dividends. Despite accumulating worries around higher input costs due to inflation, higher cost of capital, and the potential effects on margins, the most recent quarterly earnings results have been very encouraging. Of the 54 per cent of S&P 500 companies that have reported their first-quarter earnings so far, 76 per cent have beaten estimates. There is also a pick up in share buybacks. This points to the confidence that companies have in rewarding shareholders, and bodes well for the dividend outlook.

On top of this, cash on company balance sheets is at historic highs and payout ratios remain historically relatively low. Payout ratios are the percentage of profits returned to investors as dividends. For the MSCI AC World Index, the payout ratio is currently 42 per cent. This compares with an average of 58 per cent over the last 15 years.  Overall, conditions remain supportive for dividends and many companies have the potential to pay out a higher level of profits earned as dividends.

The energy, materials, real estate and industrials sectors have seen the fastest pick up in earnings and payouts. Banks and financials are also seeing their margins expand. Cash piles are also high healthcare and tech, so the prospect for dividend payments remains positive across a broad base of sectors.

Companies that pay good dividends may also have sound environmental, social and governance (ESG) credentials. We build ESG analysis into all our investment research. We have an ‘engage-ist’ mindset with the companies we invest in because we aim to raise ESG standards across the corporate sector.

Finally, valuations for global equities remain reasonable. The MSCI AC World Index is currently trading at 15.7x on a forward price-earnings basis, so well below the 5-year average of 17.7x. Despite recent market turbulence, interest rate hike expectations, and inflationary pressures, much of the risk is already priced in.

To counter inflation risk, consider adding exposure to global equity dividends. Dividends provide a dependable source of return and there are opportunities right across the globe.

The writer is senior investment specialist, equities, Asia Pacific, at abrdn.