Factsheet Commentary : August 2020

The S&P 500 and the NASDAQ in the US have a bias towards growth companies, promoting a jam tomorrow mindset among investors. In contrast, the mentality in the UK market is jam today, with UK companies in aggregate paying out a greater proportion of profits in dividends than many of their international peers. However, the COVID-19 crisis may have provided a reality check for UK companies that had been overreaching themselves in a bid to satisfy yield hungry investors.

AJ Bell’s Q2 2020 Dividend Dashboard report showed that around half of the FTSE 100 constituents had cut payouts this year, reducing the year’s forecast payout by around a third. It also highlighted the concentration risk of the UK market: the top 10 payers accounted for around 55% of the total forecast payout, while the top 20 accounted for around 74%. Adding to this concentration risk is the fact that many of the large payers operate within sectors that are, at best, slow growth and, at worst, in structural decline. Historically, some had even borrowed to satisfy investor demand for yield.

So what should an income seeking investor do now? While we can’t give individual advice, we can share what we do ourselves. For a start, we are not enticed by artificially high dividend yields.

We pursue smaller companies and invest for capital growth. As equity investors, we want our companies to invest, improve and develop strong competitive positions. Undoubtedly, taking this route lowers current income yields. However, in time, as these businesses grow and mature, we would expect that some of the earnings previously retained for investment would become available to bolster dividend payments. In this way, we accept a lower current yield in exchange for a more sustainable long term income stream and greater capital growth potential.

While we seek out quality businesses with genuine prospects for long term growth, our conservative style ensures that we do not overpay or engage in short selling*. If valuation appears to be out of whack with reality, we patiently wait or simply seek out other opportunities. We operate in a moody market and our experience has taught us that opportunities arise for investors who are prepared to be patient and discerning in their stock selection.

* The stock market is one place where perfectly sensible investors can be driven to bankruptcy by the irrational behaviour of enthusiasts as those who dared and shorted Tesla in 2020 have been painfully reminded.

Sterling Investments Management Ltd
Lynwood House 2-4 Crofton Road,
Orpington, England, BR6 8QE

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