Individual calendar years are something of an arbitrary time period to track, so I won’t devote any space to rehashing 2018. Still, for stock pickers who have generally seen the value of their investments rise each year for nearly a decade, it can take the wind out of your sails to experience such losses, even if they remain on paper.
It’s unpleasant and perhaps a little humbling, yet after a long bull market, resetting investor expectations can be a healthy thing. The same can be said for giving serious thought to topics such as rebalancing, overall asset allocation, capacity for market risk, and other factors that can affect your long-term investment performance.
Investors in dividend stocks generally don’t buy the entire stock market, and dividend-paying stocks can provide the tangible benefit of spendable income even when their capital returns disappoint. While it’s no comfort to shareholders who have suffered through a price decline, assuming that a company’s current dividend amount is safe from cuts, a lower stock price means that investors can now buy in at a higher yield.
Indeed, the 100 stocks on the Income Bellwethers watchlist are now trading at an average discount of 13% to their Morningstar fair value estimates, with an average yield of 3.8%. Two months ago, the watchlist stocks traded at an average discount of 9% and provided an average yield of 3.6%.
The Income Bellwethers research list monitors the universe of stocks with large dividends. Basic qualifications include a narrow or wide economic moat rating, meaning analysts believe the company to have a competitive advantage over peers, and current dividend yields of 2.5% or more. Income Bellwethers is a list of stocks that are widely held by income investors; it should not be regarded as a buy list.
5 UK Stocks on the Income Bellwethers List
BP (BP.)
Assuming our oil price forecast recovers during the next five years, we think BP’s debt and Gulf of Mexico payments are manageable while keeping the dividend safe.
We think BP can cover its full cash dividend at $50 per barrel. As oil prices rise, we expect excess cash flow to go toward increasing the dividend and reducing debt and repurchasing shares. Meanwhile, Gulf of Mexico payments; about $3 billion through 2018, $2 billion in 2019, and $1 billion per year thereafter, will be funded with asset sales.
British American Tobacco (BATS)
BAT’s consolidation of Reynolds represented one of the very few remaining transformative deals in global tobacco, and given the leverage in its balance sheet, it is unlikely that BATS will be involved in much further consolidation in the near future.
In the medium term, however, we think the firm could comfortably absorb bolt-on deals that will help generate further economies from its industry-leading scale.
In fact, as volume declines weigh on organic growth, we expect British American to target small acquisitions in Southern Europe and North Africa, as well as next-generation products globally, to gain market share in growth markets. The company targets a dividend pay-out ratio of at least 65%, putting it slightly below the 75%-80% targeted by its US competitors, although we anticipate a high-single-digit dividend growth a year over our forecast period.
Diageo (DGE)
Diageo is in reasonable financial shape. Diageo's current levels of debt give the firm some headroom for further leverage, a scenario we believe is quite likely, given that we expect continued industry consolidation.
Lower leverage could give Diageo more financial flexibility to act if an attractive asset were to become available in the near future. Diageo is capable of turning over 20% of its revenue into free cash flow, however, and even assuming it maintains the current dividend pay-out ratio in the high 50s, we believe it is likely to build up cash to the tune of around £1.5 billion per year in the medium term. We expect the primary uses of this capital to be reducing outstanding debt and financing acquisitions. The firm has repaired its defined benefit pension deficit, and the fund was fully funded at the end of fiscal 2018.
HSBC (HSBA)
Much attention has been paid to HSBC’s dividend, its future prospects, and its ability to return capital. We consider HSBC’s financial health to be strong. Risk-weighted assets have declined as the bank improved its capital efficiency.
The bank’s liquidity position is also strong. Customer deposits make up around 60% of group funding, equity at 10% and the balance from the wholesale debt and trading liabilities. The bank’s liquidity coverage ratio and net stable funding ratio are meeting regulatory requirements at both the group and underlying entities levels.
Unilever (ULVR)
Dividends have been the preferred vehicle for returning capital to shareholders at Unilever, and the firm has delivered slightly above-industry-average pay-out ratios of at least 60% since 2012.
Share repurchases have contributed relatively little to shareholder returns, but when management has bought back shares, it has generally done so at a level that has created value for shareholders.
It remains to be seen, however, whether the recently announced €5 billion buyback programme will be value-accretive, as the share price has reacted positively to the steps management has announced to improve performance.
We expect the firm to maintain its high dividend pay-out ratio and to be opportunistic when it comes to repurchasing shares, although mergers and acquisitions will probably remain a higher priority, particularly in prestige personal-care categories.
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