In the space of only a few weeks, we moved from a strong economic outlook to a place where one needs to consider the probability of a recession. Yet the market still expects earnings to trend higher this year, reaching 50% above the level delivered 2019.
As dividend growth investors, we tend to look at what management — as insiders to their business — tell us about the outlook. Dividends, that typically act as an insightful indicator of sustainable cash generation of a business, are expected to grow only 8% in 2022, compared to 2019. This might act as a strong signal that management is not expecting the same robust outlook as implied by the consensus earnings. Rolling lockdowns, supply chain constraints, the Ukraine/Russia conflict and secondary impacts of sanctions clearly still need to work their way through the system.
Figure 1: Dividend payout ratios suggest management doesn’t share the market’s robust outlook
Source: Bloomberg, Ninety One, as of 31 March, 2022. Global equities are illustrated by the MSCI ACWI index. For further information on indices, please see the Important information section.
With payout ratios expected to decline, it is crucial for an income investor to select the correct type of companies that will deliver durable growth over time, including through periods of economic weakness. We invest in companies with what we view as a combination of pricing power and stable revenues, which creates the potential for robust earnings growth, cash flow and finally dividend growth. We also seek to avoid expensive growth names with business models that we don’t believe are strong enough to generate excess cash and we also avoid the ex-growth companies that might have high dividend yields but can’t deliver sustainable growth.