For investors looking for profitable companies that are likely to keep paying dividends through tough times, family-controlled small and medium-sized business could be the sweet spot, according to new research.
As corporate dividends have been dumped with unprecedented velocity far and wide during the coronavirus crisis, many investors have been scrabbling around to find reliable sources of income.
It’s no secret that family firms tend to pay high and reliable dividends, as the founders and extended relatives and descendants often rely on this dividend income, which star stock picker Terry Smith flagged in a recent blog.
But analysts at broker Liberum have suggested it is not quite so simple as that.
To test their theory that small and mid-sized companies (SMID) with a strong family influence might be the safest dividend payers of all, analysts Joachim Klement and Andrew Coury dug deeper, comparing a selected basket of 234 European family businesses with companies in the Stoxx Europe 600.
The key findings were that this group are indeed more reliable dividend payers but that it’s not just a matter of investing in any family run business, as family businesses with higher family stakes have weaker performance and weaker dividend growth.
“What is needed to improve performance is family involvement with effective checks by outside shareholder,” Klement and Coury wrote in a note to clients on Wednesday.
Their findings showed companies with founders and their families as significant shareholders tend to have outperformed the broader market by 8-10% per year.
“This group are more reliable dividend payers, particularly in the SMID space where dividends are on average 1 percentage point higher and grow faster.
This stems from SMID family businesses having historically experienced 5% higher earnings growth per annum.
Top picks from the research are lighting system designer FW Thorpe PLC (LON:TFW), scientific instrument group Judges Scientific PLC (LON:JDG), office landlord CLS Holdings PLC (LON:CLI), home repairs provider Homeserve PLC (LON:HSV).
“This reliance on the income flow from a specific business is particularly pronounced for families that have large parts of their wealth tied to a single business,” the analysts said, with founders or the family often having sold parts of the business while keeping a significant stake in the business to generate reliable income in the future.
They postulated that the reliance on dividend income is probably higher for SMID family businesses than for large family businesses owned by billionaire families, “who can easily stomach a temporary suspension of dividends and live off their accumulated wealth”.
Higher margins and higher profitability seem to be the main drivers of family business outperformance in the long run, the analysts said, noting that SMID businesses also enjoyed higher growth rates in the past.
“However, what matters to income investors is the size of the dividend payments and the reliability with which these dividends are paid.”
The dividend cover ratio for SMID family businesses is higher than for large family businesses despite the fact that SMID family businesses have higher dividend yields than large caps.
There are 43 SMID family businesses in the research with a dividend yield of 3% or more but only 11 large family businesses that do so and SMID family businesses are also more attractive income stocks, the analysts said, because they tend to grow their dividends faster than large caps.
Dividend cover ratios for SMID family businesses was also found to be higher than for large family businesses despite the fact that SMID family businesses have higher dividend yields.