Investors are instinctively suspicious of high-flying dividends but today they’re absolutely paranoid, as payouts crash to earth again and again. Before investing in any stock, you need to be confident that the dividend is secure, because if it plummets the share price will instantly follow.
Chinese Arithmetic
Global bank HSBC Holdings (LSE: HSBA) soared as investors clambered on board, delighted by its exposure to booming Asia and China, unaware of the turbulence ahead. Briefly labelled the “good bank” after the financial crisis because it didn’t need a government bailout, performance has been pretty dreadful since, with the stock now 30% lower than it was five years ago.
It continues to fall, dropping 15% in the last six months, as China wreaks havoc on the global stage. This leaves it trading at a tempting 10.4 times earnings, and crucially for income seekers, yielding a juicy 7.2%. But is the yield now flying too close to the sun?
Cover bother
Currently, HSBC’s yield is covered 1.4 times, which is relatively respectable. But just as you should never judge a book solely by its cover, you also have to dig deeper with the dividend. Last year, Standard Life fund manager Thomas Moore did just that, and ended up offloading HSBC, warning of “pedestrian dividend growth” or worse. With the bank shedding jobs to cut costs, and forced to set aside increasing amounts of capital to appease regulators, Moore warned that funding the payout will prove tough. That was half a year before China crashed.
High compliance costs, fines and low interest rates will make it tough for Stuart Gulliver to fulfil his pledge to boost shareholder payouts. Last year, 50,000 jobs were culled in a bid to keep the income flowing, while unprofitable units were dumped. Worryingly, Gulliver is doubling down on his losing China/Asia bet, while the market meltdown imperils investment banking profits. The dividend looks secure for now, but Gulliver’s gamble must pay off to ensure it’s covered in the years aead.
Our friend electric
If you hold utility giant SSE (LSE: SSE) in your portfolio, you’re almost certainly doing it for the income as growth prospects have been less than electric in recent years. That said, it has done exactly what utility stocks say on the tin, providing defensive solidity in troubled times, with the share price down just 4% over the last year. Over five years, it’s up a solid 18%, while the FTSE 100 is slightly down over the same period.
SSE is nevertheless all about the yield, and it currently distributes a heartwarming 6.31% covered 1.3 times, slightly below management’s long-term target of 1.5. Until relatively recently, management was promising above-inflation dividend payouts, and still says it will hike the dividend at least in line with RPI inflation (1.2% in December). That will prove quite an effort, given that cash flow didn’t cover the dividend last year.
As with HSBC, SSE’s payout looks safe for now, but the flat outlook for revenues and profits over the next year suggests management faces an uphill struggle fulfilling its pledges to investors in the longer term.