UK Equity: A Means To A Dividend?

by Colin Morton, Vice President, Portfolio Manager, Franklin UK Equity Team Franklin Templeton Investments

Even in the face of Brexit uncertainty, the story of UK equities is not one of unremitting woe: There remain plenty of reasons to stay engaged, in our view.

One area on which we’re particularly focused is dividend growth.

While the valuations of UK equities have fluctuated amid the Brexit debacle, we’ve continued to see some really interesting dividend growth across a whole range of sectors over recent quarters.

Certain stocks have delivered substantial dividend growth showing that businesses still have robust models in place and are seeing good profit growth.

Short-Termism Creates a Value Gap

If UK interest rates remain subdued, we think the search for attractive equity returns could continue to underpin the UK equity market.

In general, concerns over the country’s likely post-Brexit position have led UK stock prices to decline. In particular, a lot of the UK-focused domestic stocks have fallen out of favour.

As such, we believe there remains a lot of value to be found in the UK equity market at the moment.

Growing short-termism among many investors is contributing to a valuation gap emerging: stocks with attractive yields in areas facing challenges over the next three to nine months appear cheap, while investors are paying multiples for high growth stocks that they think appear more stable.

Dividend Growth and Long-Term Performance

Our experience tells us that a strong track record of dividend growth can offer clues to the long-term performance potential of a company.

According to our analysis, rising dividends companies tend to experience greater long-term stock price appreciation versus companies that only maintain their dividends or don’t pay one at all. They also tend to experience less volatility over time compared to those companies.

We believe that these performance characteristics are a result of the strong business models and management teams committed to paying an increasing dividend through the ups and downs of the business cycle.

That said, we do not favour companies that pay out all of their earnings, because we are looking for dividend growth. We aim to seek out companies that are able to reinvest their earnings back into future growth.

We look to identify dividend growers which:

• are leaders in their industries or market niches;
• have attractive secular growth opportunities that allow the potential for improved profitability; and
• have management teams that have demonstrated sound capital allocation decisions, including investing for future growth and returning an increasing dividend stream to investors.

Certain sectors—oil, banks and mining—that feature prominently in benchmark indices may not meet our dividend growth criteria.

These sectors tend to be the sorts of areas which have had quite chequered dividend track records, and where the earnings model is more volatile. We will miss out on opportunities occasionally, but we think the process helps steer us away from stocks which don’t do so well.

We can’t predict how significant Brexit—or other geopolitical tensions bubbling below the surface at the moment—could be in the short term.

However, we continue to focus on the areas that we can understand: looking at the underlying businesses in our investment universe, the current dividend yields and the dividend growth on offer. Having done that, we believe there remain a lot of attractive opportunities at the moment.

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All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments.

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