Cashflows and buybacks: the drivers of UK dividends

Dividends have been pretty healthy in 2022. A key driver of this has been the strong performance of commodity companies, responsible for a significant proportion of index dividend distributions, amid favourable supply/demand dynamics.

Strong levels of cash generation should support their ability to pay progressive dividends even with the UK Government's recently announced 25% windfall tax.

The record level of share buybacks provides further evidence of the improved underlying health of companies since buybacks, like dividends, are paid out of a company’s free cashflows. Consequently, we place a lot of focus as investors on the free cashflow generation of our holdings, since this will dictate how sustainable their dividend and buyback policies are. This means that in our UK Equity Income strategy, we are seeing healthy dividends, and we expect these to be higher for 2022 than 2021. This reflects both a strong recovery in the underlying dividends of the fund’s holdings, as well as special dividends, particularly from the mining sector.

Despite being income investors, we are supportive of companies using share buybacks as a means of enhancing shareholder wealth creation, provided they are only done when the shares are trading at genuine discounts to intrinsic value. This is most often the case for companies that are out of favour, but highly cash generative.

The main risk to the dividend outlook is the cost-of-living crisis amid inflation at its highest level in decades. Companies that are unable to meaningfully pass on cost increases to their customers are likely to see their profits and cashflows damaged, reducing their abilities to fund dividend distributions. We believe that our long-term approach of investing in companies with strong balance sheets and cash generation across a broad range of sectors remains the prudent strategy for this environment.

Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.

The Fund is a sub-fund of Royal London Equity Funds ICVC, an open-ended investment company with variable capital with segregated liability between sub-funds, incorporated in England and Wales under registered number IC000807. The Authorised Corporate Director (ACD) is Royal London Unit Trust Managers Limited, authorised and regulated by the Financial Conduct Authority, with firm reference number 144037. For more information on the fund or the risks of investing, please refer to the Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page of this website.