2020 has been a year to forget for dividend investors. And we are not even at the back end of summer yet! Record payouts were delivered for another year in 2019. But the coronavirus outbreak has smashed the chances of another all-time high this time around. Even the most robust dividend stocks have had to cut, cancel or suspend payouts in response to the crisis.
Around half of FTSE 100 constituents have already taken the hatchet to dividends in anticipation of an economic storm. Even alumni like Royal Dutch Shell — a blue-chip that hadn’t cut shareholder rewards since World War 2 — have been forced into drastic action. A look at the deteriorating balance sheets of UK-quoted companies suggests that more trusted dividend stocks will be shaking up their payout policies too.
UK debt balloons
According to a study by global asset management group Janus Henderson, corporate debts are surging all over the globe. The total hit a record $8.3bn in 2019, it says, up 8% from the prior year. It was driven by “debt-financed acquisitions, large share buybacks, record dividends, and the chilling effect on profits caused by trade tensions and a global economic slowdown.”
Debt levels on the books of UK companies really exploded at an even faster rate. Net debt across London-listed firms rocketed 10% year on year to $539bn, Janus Henderson notes. According to the report, “Vodafone was responsible for half the increase, funding its acquisition of Liberty Global, while Shell borrowed heavily to help fund its $15bn dividend.”
Careful now
This debt boom clearly couldn’t have come at a worse time given the current Covid-19 crisis. On the plus side, Janus Henderson notes that “half the UK companies in our index reduced their borrowings last year.” That should give investors some crumb of comfort. Though of course, buying dividend stocks still needs to be treated with extra care right now.
Investors need to pay extra attention to net debt levels as well as free cash flows when choosing dividend stocks. It’s also important to consider how well their operations can weather a global economic downturn and therefore how profits growth is likely to turn out. Another useful thing to consider is dividend cover. This looks at how many times over predicted dividends are covered by anticipated earnings.
A top FTSE 100 dividend stock
So which UK dividend stocks would I buy based on this criteria? Well let me give you an example. I have my eye on BAE Systems and its 4.6% forward dividend yield. Net debt is falling (down 18% in 2019), free is cash booming, and it can rely on its recession-resistant businesses to continue driving profits over the medium term. To put a cherry on the cake its predicted dividend for 2020 is covered a healthy 1.9 times over by estimated earnings.
Investors need to be especially careful when buying dividend stocks today. But rising debts and a global downturn don’t mean that there are no brilliant income shares to be bought. In fact, the stock market crash allows us to buy top dividend stocks (like BAE Systems) at a hefty discount. You just need to know where to look.
