Dividends: new era?

Changes in the market

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Over the past year, we have seen significant announcements from major companies such as Meta, Alphabet, Salesforce and Booking Holdings which have driven their share prices higher. These companies have all done one thing in common: initiated a dividend.

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To dividend growth investors such as us, this is an extremely positive change in capital allocation by some of the world’s largest and most powerful businesses.

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What has prompted this change?

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We believe there are several reasons.

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Firstly, the higher levels of interest rates means there is greater competition for investors’ capital, and there are few better ways to remind investors of your prodigious and high-quality cash generation than to return a portion of it through a dividend.

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Another common trait that might have prompted this change is that these companies have very strong balance sheets. For example, at the time of writing (July 2024) Alphabet had $108bn of cash and securities on its balance sheet and the others are all net cash. Why not remind investors that they are extremely well financed?

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It is also important to remember that the ultimate decision to initiate the dividend is made by the Board of Directors collectively. We have observed that as these companies have matured, the board composition has evolved. Whilst initially they had strong representation from those who helped “build” the internet, newer members typically have extensive listed company experience – and often with companies that have a long and rich history of paying dividends. It seems natural that they would be keen on dividends as a form of capital allocation.

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Signals in initiating dividends

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There are also idiosyncratic reasons why this makes sense for these companies.

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In the case of Meta and Salesforce, both companies have been criticised in the past for either profligate capital expenditure or being overly acquisitive. By initiating a dividend, they have introduced a disciplining factor that should create a tension within the capital allocation decision making framework, leading to superior decision making whilst also reassuring investors.

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Meanwhile, in the case of Alphabet and Booking Holdings we interpret a different type of signal: one of confidence. The message we think they want to convey to us is that they have won their markets (respectively, search and online travel) and believe their competitive advantages are now so strong that they can both reinvest and pay growing dividends back to shareholders.

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Finally, it has also become more commonly understood that companies that pay a growing dividend outperform with superior risk adjusted returns¹. Who wouldn’t want to be part of that?

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Sustainability label. The Financial Conduct Authority (FCA) has issued new standards governing the use of sustainability vocabulary in the promotion and description of fund and asset management services. Funds may adopt one of four FCA labels describing their approach, or they may opt not to have a label. For reasons discussed below, Dundas has decided for the present to operate without a label for its two UK domiciled funds – Heriot Global and Heriot Smaller Companies.

Dundas makes investment decisions in large part based upon audited annual reports which in recent years have expanded to address wider sustainability matters. Disclosure on CO₂ emissions and sustainability has improved but remains incomplete, inconsistent, and heavily reliant on estimation. In response new IFRS Sustainability accounting standards were issued in 2023 (now out for adoption across the world outside the USA, where GAAP standards are moving in the same direction) effective 1 January 2024. Dundas welcomes the new standards. They are thorough, stringent and, when fully adopted, will raise and level the playing field for corporate sustainability reporting.

Dundas is already engaged with the companies in which it invests about the new standards. We will re-evaluate the appropriateness of adopting a label once our analysis of improved sustainability reporting is complete.

Sustainability Goal: to invest in companies with long-term growth potential that are simultaneously becoming more environmentally and socially sustainable. Progress will be measured largely via reporting under the new IFRS Sustainability standards. Dundas believes that companies which shoulder these responsibilities and communicate effectively will gain competitive advantage which is why we advocate for sustainable practices by those we invest in.

Investment Policy and Strategy: Dundas invests in global equities for dividend and capital growth with an investment horizon of five years or more. Where dividend growth leads, share prices follow. Sustained dividend growth is produced by well managed companies that respect all their stakeholders’ interests. The case for responsible investment in sustainable businesses is readily made by its opposite. A portfolio of irresponsible companies with unsustainable businesses will not meet clients’ long-term investment needs. The actions of the companies Dundas invests in (i.e. the enterprise contribution) are the main driver of sustainability metrics.

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Accessing other relevant information: the sustainability disclosures section of the Dundas website discloses all relevant information.

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