A handful of promising income stocks to buy now

Are dividends bad? I think regular readers will know our answer to that (no). But the political view isn’t quite the same. It became obvious about two weeks ago, says James Coney in the Sunday Times, that they were going to be one of the mega casualties of this crisis – payouts to be seen more as “morally unacceptable, a gratuitous thank you note to shareholders at a time when companies need the capital” than as a standard reward for the provision of long-term capital to the corporate sector.

There’s some sense in the ban on bank dividends (although we very much disapprove of dividend controls in general). Regulators clearly want banks to be part of the solution, not the problem – and with 2009 in mind, that’s fair enough. But full on demonising, as Coney points out, is not on.

That’s partly because it’s generally tough on savers – particularly in a world of pensions freedom. It’s also because without honest dividend yields desperate savers will look elsewhere. This will be “manna from heaven for the scammers and phoney savings firms touting their business on the internet.”

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But the real problem goes even deeper than that. Dividends are the lifeblood of the financial system – you can muck around with different valuation techniques to your heart’s content, but in the end an equity is worth the present value of the flow of dividend payments (or other income) you expect from it (this is why dividend controls are usually a sell signal). The only thing to really argue about is how you define that present value.

But without a payment or the real expectation of a payment what is an equity actually worth? And why would anyone put money into the public markets? Quite.

That has implications for the way in which business might raise capital (in private markets) and even for inequality (the fall off in growth companies listing could be one driver of wealth inequality). Public markets matter.

I’m extrapolating a lot from a short-term cancellation of bank dividends here. But it is something to watch.

Where to go for income

In the meantime where should you be going for income? You can pick stocks yourself, of course. The sectors where you will see the worst of the dividend cuts are obvious (and also much the same as in 2008-2009) – banks, real estate, metals and mining, hotels, leisure and vehicle components.

Those that will suffer least (or even be able to keep dividends stable or rising are also obvious (and again very 2009) – software, healthcare equipment, healthcare providers, consumer staples, retailing, plus of course very well run firms in any sector with low debt and a good cash reserve.

Look at the likes of Reckitt Benckiser (LSE: RB) – which makes the Dettol products. It is unlikely to find itself in cash flow difficulties in a hurry. However most of us will still want to diversify with a collective investment. I looked at this here earlier in the week.

Jonathan Jones and Taha Lokhandwala, writing in the Telegraph, agree with me that looking to investment trusts is a particularly good way to go if it is income that you need. They note that Law Debenture (LSE: LWDB) (one of the trusts in Moneyweek’s investment trust portfolio) has the most reserves (and hence ability to keep paying out its dividend without the board having to get approval to pay out of capital) in the income trust sector. They also suggest JP Morgan Claverhouse (LSE: JCH) and, for those keen to look beyond the UK for income (which you should be – see this week’s magazine for more on why Japan should be an increasingly large part of an income portfolio), Majedie (LSE: MAJE) (although this has had a huge bounce in the last week) and the Aberdeen Diversified Income and Growth trust (LSE: ADIG), which holds gold and property as well as equities and bonds, and is trading at a significant discount to its net asset value.

Another to look at might be the Guinness Global Equity Income Fund. I wrote about this one back in 2013 suggesting it as a small, low cost way to get access to an actively managed source of global income. Today it is a pretty big fund (£0.9bn) and the top performing fund in the IA Global Equity Income Sector since its launch (a zero weighting to the financial sector coming into this crisis will have helped).

It’s also a reminder that those looking for income should be careful not to rely on any one market. The UK has been a high-yield market for some time – but it has also long been a market in which that yield has been at risk. If you want long term sustainable income from quality companies make sure you are with a manager who has diversified globally in companies with strong balance sheets.