The case of the disappearing dividend

Reckitt Benckiser, the healthcare products group, last week held its dividend at 25.5p a share, despite a 24 per cent rise in after-tax income, strong cash generation and a robust balance sheet. A few days earlier, Glaxo SmithKline upped its dividend by just 2.6 per cent, less than a fifth of the rate of growth in its earnings, while Reuters halved its payment.

Investors have already had to accept dividend cuts from companies with plunging sales and soaring debts - think of Royal & Sun Alliance, British Airways or Marconi. If more robust companies are now rationing pay-outs, where can an investor go for income?

If the pundits are right, dividends could be under pressure for some time. Gareth Williams, equity strategist at ABN Amro, estimates that cashflow by companies in the UK stock market accounted for less than 10 per cent of dividend payments last year. He expects that to rise to 60 per cent this year, but says it will be 2003 before cashflow is high enough to fund payments to investors.

Small wonder, then, that he expects dividends to grow by just 4 per cent a year for the foreseeable future, less than half the average in the latter part of the 1990s.

In part, slower dividend growth reflects the slowing economy. Profits are falling or even disappearing, so dividends are being cut. Some are tempering their dividend growth in the expectation that profits growth will be slower. Others - like Glaxo and Reckitt - want to rebuild cover, the technical term for the amount of profits paid out in dividends. Internationally, profits after tax are at least twice the level of dividend payments; at Reckitt, cover is just 1.9 times, even after last year's low pay-out.

But the lower dividend payments also reflect a move towards the American fashion for share buybacks. There, the tax system so militates against dividends that some giant corporations have never paid one. Glaxo has bought back £2 billion of its shares and has permission to do the same again.

There are still pockets of robust growth, however. John Hatherly, head of global analysis at M&G, points out that banks still provide attractive income growth: Barclays has upped its dividend by 15 per cent; LloydsTSB by 10 per cent. And stocks that do offer a good income have been racing ahead since the technology bubble burst almost two years ago. The Dogs of the Footsie, a high- yield portfolio described in this column in January, has beaten the market by almost 10 per cent this year.

Despite the perception of shares being for capital growth, dividends are actually far more important to long-term performance. According to research sponsored by ABN Amro, the capital value of equities grew by an average of 5.1 per cent a year over the last century. If dividends had been reinvested, that would have doubled to 10.1 per cent - and M&G's Hatherly thinks that, if the past two decades of soaring share prices are excluded, dividends would account for more than two-thirds of the growth. It pays to look for the pay-out.