No Pain, No Gain: Don't be fooled - dividends are risky business
Saturday 01 November 2008
In these bleak, uncertain times, some of the traditional rules that govern investment decisions should be unceremoniously tossed out of the window. What were once regarded as invaluable guidelines, such as dividend yields and price earnings ratios, are now often completely useless.
A startling illustration is provided by HBoS. The published statistics say that the shares could offer an astonishing dividend yield of around 70 per cent. It's a joke – yet also another splendid illustration of that investment adage that the past does not guarantee the future. For the calculation compares the current share price with last year's dividend. It bears no relation to current – or future – prospects. I think every investor realises that the Government's bail out will prevent HBoS paying any dividend. Indeed, the bank was so strapped for cash that its last payment was made in shares. And to add insult to injury, the value placed on them for the dividend calculation was far too high. Lloyds TSB, expected to take over HBoS, is, under the rescue proposals, also unable to reward shareholders. Yet its shares offer a seemingly irresistible 21 per cent return.
Westminster may be forced to abandon its no-dividends-rule. Even so, I think it unlikely that Lloyds will feel able to justify that unprecedented yield.
It is not just the banks that are challenging the published statistics. What about BT? I said a few months ago, when the telecommunications behemoth offered a return of around 7 per cent, that there was little chance of any dividend cut. Well, I've changed my mind. The shares have continued to decline. If BT holds its payment, the payback will represent a 12 per cent return. Surely, too good to be true? Still, even if the distribution is halved, the yield is still attractive and would give the shares genuine income appeal.
Others with alleged sky-high yields include pub chains Enterprise Inns and Punch Taverns and that once indomitable retailer, Marks & Spencer. Punch has already said that it is cutting out its final dividend altogether, and there are obviously doubts whether the other two will hold their payments.
As for price earning ratios, there are some laughable calculations still being quoted. Like dividend yields, they are usually based on last year's performance. For example, Punch, at around 110p as I write, is selling at only 1.1 times last year's earnings. In March it was nearly six times. Last year, when the stock market was riding high – it seems light years away now – the shares topped 1,400p.
Prospective price/earnings ratios must also be suspect. The country is already in recession and many profit estimates should be taken with the proverbial pinch of salt.
With so many dividends in doubt, and shares in ragged retreat, shareholders are losing out on income as well as capital. HBoS' manoeuvre to offer shares instead of cash is unlikely to set a trend. Alleged yields suggest many dividends are threatened. Investors must brace themselves for cuts, some quite savage, and the complete disappearance of some dividends.
I hope my pessimism is misplaced. Some companies enjoy reasonable dividend cover and could be in a position to repeat last year's payment. Shares of high-yielders that hold their dividends are enticingly cheap. But for many, i t will be tight. For example, BT's last distribution was covered only 1.3 times.
The expected dividend casualties are not confined to well-known stock market names. There are some ridiculous yields among smallcaps. Pubs 'n' Bars, a constituent of the No Pain, No Gain portfolio, is offering a near 19 per cent return. Yet it has already missed its interim payment and may not pay a final.
I am, however, pleased to see that Mel Belligero, chief executive of the pubs chain, and Siva Namasivayam, finance director, have added to their shareholdings. It is also a buy story at financial group, Lighthouse, another portfolio constituent. Joint chief executive Allan Rosengren and another director, Alex Scott-Barrett, have lifted their stakes.
It is encouraging when directors buy shares in the company they run. Of course, it is not always a bear signal when they sell – sometimes the cash is really needed, say to help pay for a divorce or meet school fees. But it is impossible to regard director share sales as a vote of confidence.
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