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Dividends can make a major contribution to the total return you get from shares over time. But at moments of heightened economic uncertainty, it can be hard to know for sure whether a stock's payout will remain intact.
One measure that tells you more than most about a company’s dividend policy is its payout track record. If you can find a history of dividend growth - especially if it’s matched by earnings - then it could be a promising sign. One stock with a track record like this is Investment Services group, Impax Asset Management (LON:IPX).
Problems with high yielding shares
To understand why dividend track records are important, it’s worth briefly exploring one of the big challenges in income investing…
When it comes to dividends, investors often look for the biggest bang for their investment buck - which means focusing on the yield. Yield is calculated by dividing the dividend per share by the price per share - and changes to either of them will impact on the yield. This is where you find a classic problem with high yields - and that's they can be attached to troubled companies.
When share prices sink lower, the yield on a dividend-paying stock will rise. It’s then up to the investor to decide whether the market has been unfair or whether the high yield is actually a signal that the payout might be cut. This can be very difficult when the economic outlook is even less certain than normal.
Why dividend growth is useful
Most income strategies use protective measures to avoid dividend cuts - and this is where a history of payout growth comes in.
It can be preferable to see regularity and dependability in the dividend, rather than just high yield. That’s because consistent, progressive dividend policies can be a pointer to well-managed firms. It can suggest that management are cautious but confident in growing dividends in line with growth in the overall business.
This view is supported by various studies, including one by the fund managers Cliff Asness and Robert Arnott. They examined the relationship between dividends and future earnings and found that managers tend to signal their confidence about future earnings through the dividends they pay.
So there is evidence that long-term dividend growth - even with the occasional off-year - is a useful signal.
Analysing the dividend growth at Impax Asset Management
So how does this show up in Impax Asset Management?
Impax is a fund management business with a market cap of just over £900 million. It has been growing very impressively in recent years, helped by strong positioning in ESG and growth stock sectors. But after a blistering five-year run, market turmoil has put real pressure on its shares this year.
On a 12 month trailing basis, the company's dividend per share stands at 0.21p, and the yield on the stock is 2.99%. But after the recent price falls, the forecast yield (which is based on forecast earnings) has more than doubled to 4.20% from 2.00% since the start of 2022.
Over the past 10 years, the company has managed to grow its dividend 9 times. On a five year basis, that payout to shareholders has grown at an average compound rate of 57.9%. On top of that, the dividend is currently forecast to grow by 30.5% to 0.29p in the next financial year.
By comparison, earnings per share at Impax Asset Management have been growing at a compound rate of 52.7% over the past five years. And those earnings are forecast to grow by 40.4% in the year ahead.
That growth is important if the company wants to maintain its dividend growth track record. It's also worth noting that the Dividend Cover on the stock (the degree to which the payout can be paid from annual earnings) stands at 1.47, which means that the dividend is more than covered.
Overall, it suggests that while the market has cooled towards the stock - which has pushed the yield higher - its dividend growth record remains intact and looks set to continue for now.
A sign of confidence
A solid dividend growth track record is a useful measure for the income investor for two key reasons. Firstly, it can offer an indication about the general growth record of the company, and ideally you'll see dividends and earnings trending the same way. In addition, consistent dividend growth can give you an idea about the management's approach to the payout, as well as their confidence about the future. Few will want to make the mistake of being overly-optimistic and then find they have to reduce the payout later on.
Dividends, of course, can be cut at very short notice when things go wrong with a company or when the outlook changes. But in the search for reliable payouts over time, a strong track record is a useful place to start.
What does this mean for potential investors?
Yield, Growth and Safety are the three main pillars that support some of the most popular dividend investing strategies. But it's important to know that dividend payouts can be cut or cancelled very quickly when the outlook changes.
To get a fuller understanding of the dividend prospects for any stock, it's important to do some investigation yourself. Indeed, we've identified areas of concern with Impax Asset Management that you can find out about here.