Scottish Charity Investment - Paying Dividends?

For many charities, maintaining and increasing income is a constant challenge. In this article, we explore one of the main sources of investment income – the dividend.

An investment portfolio has often been the asset base from which to generate current income and provide for the future. In the quest for yield, it is important to review the security of that income stream and the factors that threaten it on a regular basis.

The stock market has traditionally been an excellent long-term store of value, protecting investors from inflation. A healthy balance sheet and rising earnings should support a progressive dividend policy. Put simply, the dividend can be regarded as a vote of confidence from the directors of a quoted plc as to the financial strength of the business.

Short-term movements in the stock market do not always reflect healthy trading and rising dividends. But a consistent increase in earnings and dividends suggests that capital values will rise over the long term.

Several of the UK’s leading companies have been very generous towards shareholders recently. Figure 1 highlights examples taken from the latest full financial year results of various companies. The Royal Bank of Scotland and BT have hiked their dividend distributions by a quarter – impressive stuff when you consider that’s eight to ten times the rate of inflation!

So far so good, but can it really be that straightforward? Well, not exactly. Take BP and HSBC, for example. These are two of the largest UK plcs and it is quite likely that they feature in many charity investment portfolios. Together, they represent 13.7% of the FTSE 100 and almost one fifth of the total dividend income of the FTSE. In its financial year ending December 2006, BP increased the dividend by 10.1% on the previous year. HSBC pushed its dividend up by 11%. However, both now report earnings and declare dividends in US dollars which, when translated into sterling, means UK investors have actually received little more than in the previous year.

The two highest-yielding stocks in the FTSE 100 are United Utilities and Lloyds TSB. The former, as a regulated business, has, for many years, distributed virtually all of its earnings in the form of dividends, and the pay-out has risen in line with inflation. Lloyds TSB, on the other hand, has just announced its first dividend increase in five years. Holders of Lloyds TSB shares throughout this time will have seen the spending power of this income eroded by inflation. The ill-timed acquisition of Scottish Widows meant profits from the banking arm were diverted to prop up the life and pensions business. Despite considerable pressure from the City in 2003 to cut the dividend, management dipped into reserves. They have since rebuilt dividend cover to a level at which they can now increase the payment.

The early part of this decade was tough for many businesses, and while Lloyds TSB held the dividend, many blue chips were forced to slash theirs. Scottish & Newcastle, Aviva, Royal & Sun Alliance and BT all spring to mind. All of these businesses are now operating a progressive dividend policy again. Many charities found that their investment income had frozen or even dropped, not just due to market conditions, but because gilt yields were low and transitional relief was phasing out the tax credit that charities could previously reclaim.

The dividend yield on the UK stock market is about 3.1% at the moment, although charity portfolios are likely to have a bias towards the higher yielders. Dividend growth has been very healthy recently, as shown by Figure 1. But with economic growth in the western world threatened by a tail off in consumer spending, and less willingness by the banks to lend, it is realistic to expect dividend growth to slow too. There may be a few shocks, and recent events suggest that superior dividend growth in the banking sector may be over for now. Charity trustees should ensure that their investment portfolios are well diversified to weather any storms ahead.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.