Income Investing

Equity Income

The Covid-19 pandemic has had obvious implications for companies’ cash flows and, consequently, their ability to return cash to shareholders (ie, pay a dividend). At Columbia Threadneedle Investments, we believe that there are areas of opportunity for active managers with a longer-term perspective, despite the current market turmoil.
While it is inevitable that the crisis will significantly impact most businesses over the short-term, our equity income portfolios tend to focus on companies with good capital discipline that can deliver a steady flow of dividends but are also looking to grow their earnings. That ideal combination of income with a growth tilt, when correctly identified, can generate steady, attractive dividends that will grow over time.

Navigating the search for income

Investors seeking a yield pick up over cash (and a safe haven), have traditionally bought government bonds and it is easy to see why. At the beginning of 2002, for example, 10-year German government bonds yielded more than 5% while inflation remained below 3%¹. The 2008 global financial crisis (GFC) changed all that. In some countries, investors saw yields spike and capital values plummet, amid concerns about mounting government debt and threats of default, while in others yields fell sharply as investors retreated to safe havens.

Fast-forward a decade and, after historically low interest rates and huge central bank stimulus, many government bonds are yielding precious little, while some are below zero. Investors wanting income need to look elsewhere – investing in dividend-paying equities that can deliver a strong and sustainable level of income, while keeping volatility in check.

Investing in dividend-paying equities can deliver a strong and sustainable level of income, while keeping volatility in check.

High-quality companies fit for all weathers

Intensive research is critical to uncovering these opportunities. This means focusing on companies with high free cash flows and healthy balance sheets. We consider dividends, and capital returns more generally, to be a signal of investment quality and that becomes even clearer in times of crisis such as this.
These high-quality companies are more likely to successfully navigate difficult economic conditions. As always, we would avoid chasing the highest yielding stocks. Yield for the sake of yield is typically not a sound investment strategy — stocks that are higher yielding, but without underlying earnings growth to support their dividends, may be more likely to see these cut or suspended in the future.

Looking ahead

Once the dust has settled, the process of returning capital to investors will likely remain under scrutiny, especially for those companies that have taken government assistance or have been overly aggressive in areas such as balance sheet leverage and capital returns. In this new world, we think that genuine dividend sustainability will be more greatly prized by investors.
¹Source: Bloomberg, 2020.