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Revealed! Why dividends, not profits, are a better signal for share price rises

Is the common theory that share prices increase chiefly on the back of profits rises going the way of the dodo? Not quite, I would argue, though a report released by Janus Henderson provides plenty of food for thought when it comes to predicting how stock values will move.

Research undertaken by the asset manager’s Henderson Far East Income investment trust showed that there has been a stronger correlation between dividends and share prices than profits over the past 10 years in most parts of the world. What was interesting for UK-focused investors, though, is that this relationship is stronger on these shores than anywhere else on the planet.

Neck and neck

So what does Henderson’s data show? Well the link between share price growth and dividend growth among London-listed stocks has been fractionally stronger than that between profit growth and share prices rises, with the correlation sitting at 0.66 and 0.64 respectively.

What this means is that just over two-thirds of the change in share values can be put down to dividend growth in that time, versus just under two-thirds of stock price changes which can be put down to profits expansion.

However, this difference between the impact of dividend and profit growth on price movements in the UK is negligible compared with other markets. Compare this with the correlation of 0.5 and 0.18 between share price growth, and dividend growth and earnings growth respectively, which Asian stocks (barring those in Japan) have exhibited during the past 10 years.

It’s still clear, though, that investors in British stocks shouldn’t just consider a company’s profits outlook when assessing the share price prospects of a particular stock. As Henderson Far East Income comments: “While the focus of most stock-market commentary is on earnings and profits, [our] findings suggest that investors are well advised to pay close attention to dividend growth too.”

FTSE 100 dividend heroes

It’s quite possible that demand for reliable dividend growers will be particularly robust in 2020 as the consequences of a slowing global economy undermine profits expansion across global stock markets.

Dividends might be rising at a slower rate more recently but it’s still possible to generate some brilliant income flows from share investing. And right now there are some brilliant income heroes to buy on the FTSE 100 alone. Investors need to tread carefully as there’s some titanic yielders out there like Centrica, Shell and Glencore – shares which all offer yields above 6% for 2020 – who face a significant fall in profits next year, and who may therefore struggle to meet current dividend projections from the City.

But there’s a sea of other great blue chips that look good to meet broker forecasts. Housebuilders Persimmon, Taylor Wimpey, and Barratt yield between 6.5% and 10.5%, for example, and are firms that should keep growing profits as the UK’s homes shortage drives new-build sales. GlaxoSmithKline’s rising drug sales supports its bulging 4.5% dividend yield for next year, meanwhile, while improving advertising markets and a strong balance sheet underpins ITV’s near-6% yield.

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Royston Wild owns shares of Barratt Developments and Taylor Wimpey. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended ITV. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.