While the falling dividend cover has been a problem that has been unfolding for some time, Architas’ investment director Adrain Lowcock says the extent of the drop is the biggest concern.
“Below 1.4x is of concern, but below 1x is serious,” he says. “That means that dividends are not covered by profit, which are then being paid out of either previous year’s earnings or more worryingly, debt.”
While being a concern, Lowcock cautions investors need to look through the headline figure, because it only shows the average for the market.
“There are still companies in the UK which are doing well and paying a good yield out of current profits, for example Lloyds,” he says.
“One area which continues to weigh on the overall figures is the commodity sector, in particular oil. The sector suffered from the collapse of the oil price in 2015/16 and dividend cover is incredibly low. With the oil price still languishing there are concerns over the sustainability of dividends in the long term.”
While AJ Bell’s head of fund selection Ryan Hughes argues there is currently no need for investors to panic, he says it would not be surprising if some companies decide not to increase dividends pay-outs in the near future.
“Looking further ahead, should the economy suffer a downturn which squeezes company profits, these companies would have little choice but to cut dividends,” says Hughes. “However, I don’t think we are at this point yet.
“It should be remembered that the UK remains a relatively high dividend market and there are a number of very good equity income funds that can help spread the risk of individual company disappointment such as Woodford Equity Income and Threadneedle UK Equity Income.”