AS WE come to the end of 2011, UK equities are offering historically high dividend yields when compared with bonds.
Companies which offer good yields are typically more defensive companies as more growth-orientated stocks tend to reinvest earnings rather than pay them out to shareholders.
Sectors which have traditionally been bastions for income investors include the pharmaceutical and utility sectors.
Given the low expectations for UK GDP growth and the downward revisions to expectations for global economic growth, defensive companies which are able to make progress in challenging economic conditions make attractive investment opportunities.
When investing for income, investors should take into account factors such as dividend cover, or the company’s earnings per share divided by the share dividend. This measure gives an indication of the security of the yield going forward.
The potential for dividend growth is also very important to bear in mind, particularly in a high inflation environment.
It is also essential to remember that equity income is not as secure as bond income as dividends are discretionary.
The banks famously cut their dividends during the financial crisis, as did BP following the Deepwater Horizon oil spill in the Gulf of Mexico. Investors who were heavily invested in banks pre-2008 had their fingers burned from a capital, as well as income, point of view.
With this in mind, capital security is another factor to consider when investing in equities. The rule of thumb is not to invest more than you can afford to lose. Although high dividends, to some extent, will support a company’s share price, investors are exposed to the high risk nature of equity investing.
The telecommunications sector now has similar characteristics to the utilities sector. Vodafone Group currently provides a dividend yield in the region of 8%, which is more than covered by earnings.
The yield figure includes a £2.8bn distribution to shareholders from its holding of 45% in Verizon Wireless.
Given that the owner of the other 55%, Verizon Communications, needs its share of the dividend, it is thought that this additional contribution will continue, despite the lack of a long-term policy announcement. Vodafone has, however, made no secret of its intention to grow its dividend by 7% per year.
Even typically low-yielding sectors are looking attractive to income investors. BHP Billiton, a diversified mining company, is currently offering a dividend yield of 3.4%. As dividend yields for companies such as BHP Billiton rise, income fund managers have a wider universe of companies which fall within their mandate.
Investment trusts can offer diversification benefits as well as a strong yield. The Edinburgh Investment Trust currently has a dividend yield of 4.6% and aims to grow its dividend per share by more than UK inflation. The trust is managed by Neil Woodford, whose track record has been notable.
As you might expect, pharmaceutical, telecommunication and tobacco companies feature as major themes in the portfolio. It is worth bearing in mind that the fund manager has the freedom to invest up to 20% in overseas investments and can borrow up to £200m.
Whether one chooses to invest via direct equities or collective investments, investing for income or just taking a more “total return” view, there are many opportunities for investors looking to generate attractive levels of income.
Furthermore, given the anaemic economic growth we expect to see in the UK, and the effect of European austerity measures on global growth, market conditions are likely to be supportive of more defensive stocks. Please seek professional advice.
Carmen Baylis, Chartered MCSI firstname.lastname@example.org.