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Lloyds and RBS drive FTSE 350 dividends to another record year, but is this trend sustainable?

High yields are often viewed as a warning that a company’s dividend is too high to maintain, but a new study thinks the issue lies with the value of unloved UK stocks and not their pay-outs

To figure out a company’s yield, divide the share price by the dividend

Pay-outs from London-listed companies hit an all-time high in 2018, according to a new study, despite the UK stock market enduring its worst year in a decade.

Brexit, the US-China trade war and signs of a slowing global economy all served to knock 12.5% off the FTSE 100 last year – its biggest annual decline since 2008. The headwinds also led to the FTSE 250 falling by more than 15%.

Banks start chipping in again

But dividends from the UK’s 350 biggest companies, coupled with those from other firms listed on the main market of the London Stock Exchange, hit a record £99.8bn.

A 9% hike from British American Tobacco PLC (LON:BATS) fuelled the growth, as did the banks, some of which returned to divi payments for the first time in years.

“In the fourth quarter, the Royal Bank of Scotland Group PLC (LON:RBS) paid its first dividend in ten years; in the second quarter, Standard Chartered PLC (LON:STAN) paid its first dividend since 2015; and Lloyds Banking Group PLC (LON:LLOY) is now distributing more than it did before the financial crisis,” read the report from Link Asset Services.

With share prices falling and dividends going up, yields hit their highest level since March 2009 and there is little sign of that trend reversing.

The average dividend-paying, listed company will yield 4.8% this year, while the figure for FTSE 100 firms will reach 5.0%.

To put that into perspective, the average yield over the past 30 years has been around 3.5%.

Share prices the issue, not the divis

A high yield is often a sign of trouble ahead, with investors speculating that the dividend will either be cut or scrapped altogether, but the report concluded that that is unlikely to be the case this time around.

“Even allowing for a deteriorating global economy, and company- or sector-specific problems in the UK market, a 4.8% yield in our opinion implies an overly pessimistic view on the prospects for dividends.”

More likely, the analysts say, is that high yields represent an “undervaluation” of UK stocks, which have been unloved by the markets since the Brexit vote.

“The current disconnect between the level of dividends being paid and share prices doesn’t mean share prices must rebound any time soon. Even if dividends do meet our forecast, the yield may stay elevated for as long as uncertainty persists.”

Set for record 2019

The analysts behind the report expect UK dividends to break “comfortably” through the £100bn mark in 2019, rising 4.2% to just over £104bn.

“Our forecast marks a slowdown compared to 2018. This reflects the higher risks to growth now, and the fact that the easy wins provided by the mining sector’s recovery are now behind us.”

The overall message of the report is bullish: UK dividends, despite the high yield, are not going anywhere anytime soon and equities “look attractive” compared to other asset classes such as bonds and property.

Beware of Centrica

But there was one word of caution for those who have invested in British Gas owner Centrica PLC (LON:CNA) or any of the housebuilders.

“Centrica’s dividend is much smaller, but it is barely covered by earnings and looks vulnerable, while the housebuilding sector is faced with a slowing housing market.

“The exceptionally high yields in this sector reflect investor scepticism about the sustainability of housebuilder pay-outs. Brexit concerns and those around world growth have pushed bank share prices down too, and therefore increased yields.”

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