Why dividends are set to fall

UK shares paid out their highest-ever amount of income from regular dividends last year, says Ed Monk in The Daily Telegraph. After a dismal year, this sounds like good news for investors. But the headline numbers are misleading in some ways and investors might be in for a shock if they expect the same this year.

All told, UK-listed firms paid out £87.6bn in dividends in 2015, according to Capita Asset Services. This was 10% lower than in 2014, but 2014's figures were skewed by Vodafone's £50bn special dividend after the sale of Verizon Wireless. Underlying dividends totalled £84.6bn, up by 6.8%. However, half the increase can be put down to the strengthening of the US dollar 40% of UK company dividends by value are declared in dollars rather than organic growth.

What's more, total dividends were heavily influenced by a small number of FTSE 100 companies. "FTSE 250 dividends grew by 22.6%, the fastest growth since 2011, but still only accounted for £10.2bn of the total £87.6bn paid out by companies," says Monk. "This highlights the dependency of income-seeking investors on the very biggest payers."

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Worryingly, a quarter of all dividend income in the UK comes from oil and mining companies, says Sebastian Lyon of Troy Asset Management. This is at risk from low oil prices. Several big miners have suspended payments. "At least £3.4bn of 2016 cancellations have already been announced and we may yet see more cuts," warns Capita. "Oil multinationals have signalled their intention to maintain pay outs, but smaller producers with weaker balance sheets have slashed their distributions."

Hence while the yield on the FTSE 100 has risen to more than 4%, due to market falls, this "is more a health warning of further dividend cuts to come" than a reason to celebrate, says Lyon. Given potential cuts over the next few years, "we estimate the genuine market yield may be as much as 1% lower than the stated historical level". Dividends from UK stocks are set to fall by 1.3% to £86.5bn in 2016, estimates Capita.

So investors need to consider whether dividends are sustainable, rather than just focusing on those with the highest yield (indeed, one in five income funds cut their payouts in 2015, despite the record level of dividends, notes Monk). At times like these, income-focused investment trusts can be a good alternative to open-end funds. They have the freedom to hold back cash during good years, ready for the rainy days of dividend cuts.