Should companies keep paying dividends?

By Adam Lloyd, Partner

For the first time since WWII Royal Dutch Shell, the UK’s largest and most reliable payer of dividends, has announced a two thirds cut in its quarterly dividend. A surprise, just days after BP chose to maintain its dividend, but not a shock.

In the wake of the lockdown we have seen a whole slew of the UK’s major companies scrap their dividends and more than half all UK listed companies will probably follow suit, if they haven’t already. When we look back at 2020, the sum total of these cuts could well top £50 billion.

Let’s be clear, this is a really important question that affects us all one way or another because dividends really matter. They don’t just underpin share price valuations and the stock market they provide vital sources of income for many investors, especially pensioners. If dividends don’t get paid then the burden will ultimately fall on the taxpayer and, lest we forget, those dividends get taxed - double whammy for the treasury. In any normal year the answer to the question is a resounding, “YES, companies should keep paying dividends.”

The reasons for not paying a dividend are just as clear. Business activity for most sectors is at historically low levels and in some very high profile cases, like automotive, at a dead standstill. The principal for dividends is that they get paid from profits when all other outgoings have been satisfied. With many companies seeking government assistance just to keep the lights on it is hard to make a case for paying a dividend this year. The best use of funds right now has got to be keeping businesses afloat, otherwise where will the dividend streams come from next year and the year after?

Larger companies with big balance sheets often maintain payments through downturns to smooth out their dividend flow. This is especially valued by the equity income funds which provide their investors with regular income based on dividend payments. A big argument to keep paying dividends is the high weighting of these income funds on company share registers and without dividends the income funds become forced sellers. On 22 April the Investment Association, the trade body for UK investment managers, issued new guidelines effectively giving income funds 12 months grace to continue holding shares in companies that have made short-term dividend cuts.

So for this year at least, one of the main arguments to keep paying a dividend has been removed. It remains to be seen whether the other half of UK PLC follows suite.