The UK stock market has had its fair share of woes in recent years, but has long been popular with income-hungry investors.
Those who stayed loyal to the domestic market have been rewarded with good cash returns so far this year, after dividend payouts hit a record high in the second quarter.
UK dividends rose 11.2% year-on-year, reaching an all-time quarterly high of £36.7 billion. These figures are provided by financial services company Computershare, which publishes a quarterly dividend monitor.
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While this paints a healthy picture for income-focused investors, it is important to point out that this figure received a significant boost from one-off special dividends.
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“The underlying growth rate, which strips out these one-offs, was just 1.0%, but regular payouts still reached a new record (£32.5 billion),” Computershare says.
It comes in a year when the FTSE 100 has risen to new highs. However, it continues to lag behind its US and global peers, with commentators questioning whether UK valuations will ever catch up.
As a result, UK equity funds have bled almost £55 billion in outflows since 2016, as investors withdraw their money in favour of other assets.
Why have UK dividends hit a record high?
The UK economy is starting to look a little healthier. Wages are rising more quickly than prices, meaning consumers have more money to spend – and this purchasing power is boosting profits.
Mark Cleland, chief executive of Issuer Services at Computershare, says: “Higher profits mean most sectors are paying more in dividends and spending a lot of cash on share buybacks.”
But it’s not just a shift in consumer spending power that’s driven record dividends in the second quarter. There have been some sector-specific factors too.
Banking stocks have been a key driver, after reporting record profits in 2023. Strong performance in the sector has been driven by higher interest rates, which have boosted earnings significantly.
Computershare says the highest one-off payout this quarter came from HSBC. The bank announced a special dividend of 16.7p per share after selling its Canadian arm.
Which sectors are paying the best dividends?
While banks had the largest impact by some margin, the healthcare sector also made a positive contribution to dividend growth. This was primarily a result of strong profit performance at Haleon and GlaxoSmithKline, Computershare reports.
“Insurance, property, industrials and food retail were [also] among the mix of sectors showing good growth,” the company adds, while high oil prices supported “modestly rising” dividends from the major oil companies.
Meanwhile, housebuilders (which are struggling with the impact of high interest rates) were one of the weakest sectors. There are hopes the sector could pick up later this year once rates start to come down, particularly after the new government announced plans to “get Britain building”.
The mining sector has also been a drag on dividend growth, with miners cutting their dividends by 33% year-on-year.
This is significant, as the sector has a big influence on the fortunes of the overall UK dividend landscape. Since 2015, it has been responsible for around one third of all dividend variability, Computershare says.
What’s next for UK dividends?
The rate of dividend growth is likely to slow going forwards, as the miners continue to drag on dividend performance. For example, mining giant Glencore has announced a larger-than-expected cut to its third-quarter dividend.
The “mining effect” has prompted Computershare to downgrade its full-year dividend growth forecast to just 0.1%, down from 1.5% three months ago. This means the company now expects regular dividend payouts to come to £88.2 billion for 2024 as a whole.
If the miners were excluded, Computershare says we could be looking at double-digit underlying growth across the UK market as a whole.
This isn’t the only factor at play, though. Sam North, market analyst at eToro, adds that interest rate cuts could also have a knock-on effect on the dividend outlook.
He says: “As interest rates decrease, dividend-paying companies might find themselves under less pressure to maintain high dividend yields, as investors may not have access to top savings rates.
“This could potentially lead to a slight reduction in dividend payouts, allowing companies to allocate resources towards growth and expansion.”
Should income-hungry investors buy UK equities?
Even if dividend growth is expected to slow in the second half of the year, the UK market still looks competitive from an income-generation perspective.
The FTSE 100 currently has a yield of about 3.6%, according to data from Hargreaves Lansdown. Meanwhile, the S&P 500 offers around 1.3%.
“That’s a function of several factors,” says Derren Nathan, head of equity research at the investment platform. “A key one is the relatively large discount in valuation which in part reflects the higher weighting of mature industries such as financials and commodities”.
Meanwhile, the US stock market has a strong tech bias. Growth initiatives in this sector place a greater burden on surplus capital, Nathan adds, meaning management teams often choose to reinvest any cash rather than paying it out to investors.
That said, investors should remember that income is only one component of overall returns – and the US market has shown a far greater capacity for growth in recent years. The S&P 500 is up more than 16% year-to-date. In contrast, the FTSE 100 is up just over 5.5%.
Income potential may not be a good enough reason to invest in UK equities, particularly when some cash accounts are offering rates of 5% or more with no investment risk at all.
Of course, that’s not to say investors should stick all their money in cash – the stock market almost always beats cash returns over the long run. The bigger point is that it is important to consider growth alongside income potential.
The UK market does look undervalued, as it has for some time, but nobody knows if or when its fortunes will finally change. With this in mind, you might be better off hedging your bets and spreading your investments across a range of different regions.
