Growth prospects 'sacrificed' as UK companies splash out on dividends

Billions showered on shareholders after years of cuts. But some in the City believe largesse is bad for Britain
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The Independent Online

UK companies have announced plans to shower more than £8bn of cash on shareholders via dividends in the past week alone, and investors can expect more of the same as another earnings-loaded week kicks off tomorrow.

The wave of payouts follows several years in which companies cut dividends and concentrated on getting their financial houses in order. Analysts, meanwhile, are forecasting another strong year of growth for equities.

But not everyone is rejoicing over corporate Britain's newfound largesse. Clive McDonnell of Standard & Poor's Equity Research sees it as an ominous sign, warning that company managers are sacrificing their long-term prospects to appease investors today. "If you are investing a smaller proportion of earnings in future growth and return on equity is stable, the rate of growth will decline. It's a simple one-plus- one situation."

Increased dividends have been spurred by the improving fortunes of businesses, which have benefited from a combination of factors: the rising prices of commodities; the value released by the continued dismantling of conglomerates; and the recovery of mature, cash-generative businesses.

Abiding by the principle that a rising tide lifts all boats, groups such as BP, BHP Billiton and Anglo American unveiled record dividends this month after hitting all-time earnings highs. But companies that have disappointed - such as Rentokil Initial, Centrica and, for years, Lloyds TSB - have also maintained high payouts.

It is forecast that the S&P Europe 350 index will increase its payout ratio - the percentage of earnings that groups pay in dividends - to 43 per cent in 2006, up from 41 per cent in 2004. This stands out relative to the US, where the ratios are expected to fall from 33 to 32 per cent.

According to Mr McDonnell, the fall in US dividends reflects the rising confidence of managers who are looking to put money to work to ensure good long-term prospects. Conversely, the rush among European companies to give money back is an indication of a "dearth of attractive investment projects".

Fund managers, often vocal defenders of dividends, don't agree. "That kind of view is nonsense," said Ed Burke, a fund manager at Invesco. "If you don't have dividends, you don't have much in returns. There should be no conflict between investing in the business and having sustained dividend growth."

Investors point to the spate of ill-fated mergers and acquisitions that dominated the late 1990s and early 2000s to support the argument that dividends save managers from themselves - acting as a control on executives who would otherwise be liable to throw money after ill-advised projects or acquisitions.

"If they have less of their earnings available to invest, they will generally be more disciplined and less inclined to build little empires or spend willy-nilly," said Tineke Frikke of Newton Investment Management. "I'm a firm believer in a balanced payout ratio." For Ms Frikke, that would be "50 per cent or even a bit more".

But has the pendulum already swung too far? The S&P Europe 350 rose by 23 per cent in 2005. But a closer look is revealing. Of the 10 sectors that comprise the index, the top four by share-price performance - materials, industrials, energy and healthcare - are the only ones expected to cut their payout ratios this year. Those forecast to make the biggest hikes in the ratios are among the worst performers.

In telecoms, analysts expect the sector to increase the payout ratio from 39 per cent in 2004 to 58 per cent this year. As the industry's growth rate slows, so the theory goes, chief executives are becoming much more generous with their dividends to keep investors faithful. The 19 per cent payout jump is the biggest of all the sectors on the S&P Europe 350, yet telecoms shares sank by 2 per cent - the only industry on the index to register a decline.

Fund managers are quick to mention reports in previous years showing that, counter- intuitively, companies granting higher dividends produce better long-term earnings growth.

Ms Frikke said: "Everybody could do with a bit of discipline."

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