There are two great joys to being a long-term shareholder in companies. The first is the capital gains (profits) made by selling shares at higher prices than one paid for them. The second is the passive income one collects from firms that pay regular cash dividends to shareholders.
Dividends die in the third quarter
Now for awful news for dividend-loving shareholders and value investors. In the third quarter of 2020, the dividends paid by UK-listed companies almost halved, collapsing by 49.1% to just £18bn. This is the biggest plunge in Q3 payouts since 2020, according to this report from Link Asset Services.
According to Link, two-thirds of companies listed in London cut, cancelled, or suspended their dividend payouts for the summer season. Clearly, given the economic ravages of the coronavirus, British companies decided to conserve cash. Instead of doling it out to shareholders, they elected to keep cash on their balance sheets to help ride out the downturn.
In Q2, payouts collapsed by 57% to £16.1bn, so at least the third quarter improved on the second. For 2020 as a whole, Link expects total dividends to dive by almost two-thirds (39%). This massive shortfall (estimated at £60bn) is a brutal blow for pensioners and investment funds at a time of ultra-low interest rates. In effect, UK dividends have rewound eight years, back to 2012.
This FTSE 100 firm pays 6% a year in cash
To bank steady dividends today, investors need to exercise caution. For me, the most reliable payouts come from big business leaders: powerful companies with strong balance sheets, revenues, and cash flows. Take, for example, GlaxoSmithKline (LSE: GSK), one of my favourite British businesses.
Before the coronavirus devastated economies and markets, GSK shares were flying high. They hit a 52-week peak of 1,857p on 24 January, but plunged below 1,375p at the market trough on 23 March. The share price then rebounded above 1,742p by 13 May, but has since slumped. As I write, GSK shares hover below 1,340p, even lower than their March bottom.
The good news for buyers of GSK shares today is that they pay a monster dividend. It’s the fifth-largest by size in the FTSE 100, in fact. GSK’s quarterly dividends total 80p a share, for a current dividend yield of 6%. Even better, this dividend is solidly covered 1.64 times by GSK’s yearly earnings. This bumper passive income is why I own GSK shares today and have done for decades.
This is the second-largest dividend in the FTSE 100
British American Tobacco (LSE: BATS) is my second ‘dividend darling’. It’s a value share that I’ve written about repeatedly since the dark day of March. Obviously, as the #1 cigarette maker in the world, BATS is certainly not a stock for ethical investors. But it’s an enormous global business with loyal (and addicted) customers, huge revenues, and strong cash flows.
As recent as 15 January, BATS shares hit a 52-week high of £35.07. Today, they trade almost £10 cheaper, after closing at £25.50. This makes BATS shares notably cheap, given their price-to-earnings ratio of 9.3 and earnings yield of 10.8%. What’s more, they offer a whopping dividend yield approaching 8.3%, covered 1.3 times by earnings.
In summary, as a value investor looking for income, I love the delightful dividends of GSK and BATS (which are at opposite ends of the healthcare system!). I’d happily buy both shares today inside an ISA so as to collect tax-free future dividends and capital gains.