With hundreds of millions, if not billions, of consumers and workers being forced to stay at home to combat the pandemic, companies are inevitably going to be tested over the coming months. For some businesses, there will quite simply be less cash to distribute to their shareholders in the form of dividends. For a few, there will be none at all.
On the face of it, this makes it a harder environment for dividend investors. Yet for those of us investing for a rising long-term income, it has undoubtedly created opportunities.
The importance of being selective
The sell-off across global stockmarkets in March 2020 has been remarkable. As a result of investors dumping company shares to generate cash, valuations are not only suppressed but, in my view, extraordinarily low in many cases.
An advantage of market volatility is that it creates exceptional openings to buy shares at very low prices, historically speaking. After the sell-off, many sound companies have traded with dividend yields – the prospective annual dividend income as a proportion of a share’s price – well into double-digits. This was inconceivable only a few months ago.
In an environment where dividend cuts are going to become more common, it is a time for income investors to be selective. After all, stronger companies will be better equipped to continue rewarding their shareholders in the current climate. Having net cash on their balance sheets is an indicator that companies will be better placed to sustain their dividends.
Conversely, I would be wary of investing in the shares of companies entering this recession with excessive borrowing. When companies have to restructure their debts, shareholders often lose out as creditors set the terms or have first claim over assets.
The opportunity to go for growth
Looking beyond short-term prospects, I think it is important for investors targeting a rising income from dividends to consider the long-term growth that companies have the potential to achieve.
A fast-growing company’s dividend yield may be relatively low today, but if it can consistently raise its dividend over time, the income stream from your original investment could end up becoming substantial in future years.
Companies that offer strong growth prospects are typically prized by investors, meaning you often have to pay handsomely for future income. At times like this, when share prices have fallen across the board, there is a chance to buy into those fast-growing stocks whose long-term trajectory remains intact at more attractive prices than have been possible in recent memory.
The danger of mis-timing the market
There is always the temptation during a stockmarket funk to try to avoid further pain and to wait until there are clear signs of recovery before investing or reinvesting. In reality, it is almost impossible to get the timing spot on.
While staying on the side-lines in the face of uncertainty may feel like the lower risk option, history shows us how excessive risk aversion can prove costly in the long run.
Stockmarkets may yet fall further before investors see a light at the end of tunnel. When they do regain confidence in the future, however, I believe the market recovery not only has the potential to be significant but also quick.
It may take days, weeks or months before we turn the corner. However, if you are not invested at the time of that rebound in global share prices, the opportunity will be permanently lost.
Past performance is not a guide to future performance.
The value and income from a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.
The views expressed in this document should not be taken as a recommendation, advice or forecast.