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The importance of consistently covered dividends

The Fund Manager

This article goes back to basics and outlines why a consistent record of dividend payments is the first thing I look for in a company, and why dividend cover is the first of many ratios in my investment spreadsheet.

Dividends make up the backbone of my investment strategy, so the first thing I look for in a company is a track record of consistent and sustainable dividends.

If you’re new to investing, here’s a quick definition:

Dividend per share (DPS): Dividends are cash payments made from a company to its shareholders. In theory, cash should be paid out to shareholders as a dividend when the company cannot invest that cash within the business at an attractive rate of return.

There are several reasons why dividends are central to my approach. The most important reasons are:

Dividends support efficient capital allocation

A company should only retain cash generated from operations if that cash can be used to produce an attractive return. The main uses of retained cash are:

  • Maintaining the existing business
  • Organically growing the business (e.g. buying stock or investing in factories, stores or equipment)
  • Acquiring other companies
  • Paying down debt
  • Buying back shares
  • When those options are exhausted, cash should be returned to shareholders as a dividend.

With companies that don’t pay a dividend there is, in my opinion, a greater risk that cash retained within the business will be used to expand the CEO’s empire (and pay packet) rather than maximise returns for shareholders.

Dividends create commitment and accountability

Companies with progressive dividend policies have made a promise to investors that they will maintain or grow the dividend each year.

This provides a public and very concrete goal for management to achieve. Of course this promise can be broken, but on average dividend-paying companies have historically performed better than non-dividend payers.

Dividends are a helpful yardstick

A progressive dividend gives investors a gauge for the long-term progress of a company. While earnings (and to a lesser extent revenues) bounce around from year to year, a progressive dividend can act as a more stable indicator of a company’s underlying growth rate.

Dividends provide investors with a regular income from their investments

Perhaps the most obvious benefit of dividends is that they’re a form of cash income. For investors who want an income from their investments, dividends are an excellent way to receive that income without having to sell any shares.

This removes any confusion around what is or isn’t a sustainable withdrawal rate, because withdrawing dividends should always be sustainable.

Dividends also provide an always-positive return which is independent of a company’s share price. This can help reduce the volatility of your portfolio and provide a positive return even if (heaven forbid) one of your holdings eventually goes bust.

Looking for a long record of continuous dividend payments

Benjamin Graham, the father of value investing, once said that “Each company should have a long record of continuous dividend payments.” The logic behind this rule is simple:

If investors want to buy companies that are likely to pay a consistent dividend in the future, the best place to find such companies is among those that have paid a consistent dividend in the past.

This leads to the first of many rules of thumb which I use to guide my investment decisions:

Only invest in a company if it paid a dividend in every one of the last ten years.

Most companies pay dividends multiple times per year, so if a company missed a single interim or final dividend then that may be okay, as long as some sort of dividend was paid every year. However, if no dividend was paid in one or more years then the company goes straight into my metaphorical waste paper bin.

Although I look for a consistent track record of dividend payments, it’s important to remember that dividends are paid at the discretion of the company’s board of directors. Unfortunately, this means you can never be 100% sure that a company won’t cut or suspend its dividend at some point in the future.

The coronavirus pandemic is a good example of this. During the global pandemic, even very defensive companies such as J Sainsbury (a supermarket) or AG Barr (maker of the IRN BRU fizzy drink) suspended their dividends. This doesn’t make them bad companies, it just means sometimes the economic outlook is so bad that suspending the dividend is the sensible thing, no matter how defensive the company.

Having said that, it is possible to invest in companies where the odds of suffering a dividend cut or suspension are relatively low, and the first step in that direction is to look for a track record of consistent dividends over at least the last ten years.

Getting your hands on ten years of financial data

There are various ways to get hold of a company’s financial results for the past ten years. The obvious place to look would be the company’s annual reports, but that approach is very time consuming and any per share data, such as dividends per share, will not have been adjusted for share splits or share consolidations.

Share splits and consolidations change the number of shares a company has and the price of each share, but they don’t affect the value of each shareholder’s holdings. However, they do affect per share figures such as dividends and earnings per share, which means per share figures from older annual and interim results have to be adjusted to take account of the change.

You could correct for splits and consolidations by hand, but my preferred approach is to get ten years of data from data providers such as:

  • Morningstar
  • SharePad (or ShareScope)
  • Sharelockholmes

You can then supplement that as necessary with data from the annual results and reports, which you can find on:

  • The company’s website
  • annualreports.co.uk
  • investegate.co.uk
  • beta.companieshouse.gov.uk (including annual reports more than ten years old for when you’re doing a really deep dive on a company)

Now that we have the necessary data, let’s analyse the dividend record of a real company which has been in my portfolio at some point over the last few years.

Reviewing Ted Baker’s dividend

Ted Baker (TED) is a FTSE 250 fashion retailer listed in the defensive Personal Goods sector. It is known for its quirky British-themed style and has around 500 stores across the globe. It sells through three main channels:

  • Retail (stores and online)
  • Licences (product and geographical)
  • Wholesale (e.g. through third party department stores)

Ted had the following dividend record for the ten years to 2019:

Looking for dividend payments in every one of the last ten years is a pretty simple test. Either a company made a dividend payment in every year or it didn’t. In Ted Baker’s case it did, so at this stage of the analysis Ted would still be a viable investment candidate.

Looking for consistently covered dividends






The Fund Manager

About John Kingham

John Kingham

John Kingham is the editor of UK Value Investor, the investment newsletter for defensive value investors. With a professional background in software analysis, John's approach to high yield, low risk investing is based on the Benjamin Graham tradition of being systematic and fact-based, rather than speculative. John is also the author of The Defensive Value Investor: A Complete Step-By-Step Guide to Building a High Yield, Low Risk Share Portfolio. His website can be found at: www.ukvalueinvestor.com.

Articles by John Kingham

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