How should investors behave in the current environment? There are many studies that show high yielding shares have historically provided superior total returns compared to the broad UK market.
However, we are seeing a huge number of companies suspend or cut their dividends in response to the pressures that the Covid-19 pandemic is putting on their business, or the wider economy.
The definition of an income share depends upon which year an investor looks at. For example, a high yield in 2019 may be followed by zero income in 2020.
We tend to look a bit further out and consider what dividend yield we would expect to achieve from companies when conditions normalise for that business.
We cannot be precise on these estimates, but we have a good idea of which companies are likely to pay a decent dividend yield in 2022, say.
They broadly fall into two camps; companies that can pay a solid dividend yield throughout such as GSK, Vodafone and Tate & Lyle, and those that have suspended dividends but are likely to resume with a high yield, such as BAE Systems, Landsec and WPP.
Both of these areas offer attractive opportunities for investors. Stockmarket valuations are polarised, with higher growth or higher return on capital companies trading on quite extended valuations.
In contrast, many of the high yielders or potential high yielders are cheap, but as ever investors need to be selective.
The first group, those companies which are able to sustain dividends yet still pay an above average yield, are often not getting full credit for their defensive characteristics and should offer investors a valuable income stream plus the potential for a re-rating in due course.
The second group includes many companies that are out of favour or under pressure today. However, if they can be correctly identified as survivors, investors stand to benefit from significant recovery potential as their dividends resume in the future, especially as they often trade on very attractive valuations.
Not all companies that have suspended dividends are high risk businesses. Many are fundamentally sound companies with strong balance sheets and attractive market positions.
Simon Gergel is manager of The Merchants Trust
• High yield shares have historically provided better returns
• Valuations of many high yielders and companies that have suspended dividends are generally attractive
• We are seeing huge numbers of companies cancel their dividend payments
• Covid-19 pandemic is putting strain on businesses and the economy