Here’s some more good news for income investors

We run through an important bellwether for dividend health, which has been rebounding.

Dividend cover for global companies is set to reach its highest level since 2013, according to the latest global dividend cover report from Henderson International Income Trust (HINT).

Dividend cover is a ratio measuring a company’s income to its dividend payment. The measure is used to indicate how sustainable a company’s dividend is.

As a rule of thumb, a low dividend cover ratio – around 1x or lower – suggests dividends are vulnerable, as the company is using most if not all of its profits to fund the dividend. A figure of two or more is viewed as comfortable because it is a sign the business is not over-distributing.

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According to the latest report, divided cover is set to rebound sharply in 2021, reaching 2.1x in 2021 and 2.4x in 2022. The figure for 2.4x is the highest dividend cover has been since 2013.

The sharp rebound follows a collapse of dividend cover ratios last year. Global profits fell by 24% in 2020, owing to the pandemic and lockdowns. However, companies were reluctant to cut their dividend payments too much. In total, global dividends fell by just 8% in sterling terms during 2020, despite the severity of the loss of earnings.

The resulting combination of severely depressed profits and comparatively sheltered dividends meant that dividend cover, the ratio of profits to dividends, fell to just 1.8x. This represented its lowest level since the financial crisis. 

Now, with profits sharply rising in 2021 and, according to forecasts, in 2022, the dividend cover ratio has picked up. According to the report, markets are currently expecting profit growth of 18% this year. As a result, dividend cover ratio will increase.

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The sharp fall in the dividend cover ratio when the economy goes into a recession, followed by a recovery when the economy begins to rebound is a common pattern. As Ben Lofthouse, fund manager of Henderson International Income Trust and head of global equity income at Janus Henderson, notes: “Dividend cover initially falls in a crisis and then rebounds, as it is today, before steadily dropping again as companies loosen the purse strings during better times.”

The report, however, points out that the UK has one of the lowest dividend covers in the world. Prior to the pandemic, many fund managers had warned about the UK’s unsustainably high payout ratios and low  dividend cover ratios.