You may remember a few months ago we wrote about the significant percentage of UK 100 constituents paying dividend yields that made a mockery of high street interest rates. Refresh your memory here if not. On the one hand things haven’t changed much since. On the other, rather a lot has changed. For the good you’ll be glad to hear. Yes the 33% of stocks we highlighted paying forecast yields of 4%+ is largely unchanged. But the fact this is still the case after a UK Index rally of over 14% makes it all the more remarkable. After all, as share prices rise, the corresponding dividend yield should fall.

This implies consensus estimates for future dividends must also have increased to keep pace with the rising price. This may not be the case for every stock. For example, some shares have fallen by 19% (BT) since we last wrote while others have rallied 60% (Antofagasta), hindered by a profits warning and helped by a Trump rally, respectively. However, the UK Index index a whole still offers a healthy 34% of stocks yielding an estimated 4%+ over the next 12 months, ranging from Next on a tidy 4.0% all the way to Direct Line Insurance offering an extremely attractive 9.1%.

It could be assumed that the recent UK Index rally to record highs was solely driven by a weak GBP flattering the value of its large proportion of profits generated internationally and increasing the value of dividends paid out in EUR and USD (Trump + Fed sending USD higher; Brexit uncertainty sending GBP lower). However, you might be surprised to find, for all the volatile we have seen over the past three months, that GBP/USD and GBP/EUR are in fact 2% and 6% higher, respectively. If anything this should mean a headwind for the shares. Meaning other reasons can be credited.

The UK economy is holding up better than anyone could have expected despite an uncertain Brexit scenario. The UK 100 is also rather insulated by so much of its activities being ex-UK. With Q3 and full year 2016 results now in the rear view mirror our updated statistics (34% of stocks yielding an estimated 4%+, 75% on 2%+) implies an outlook positive enough for analysts to forecast further revenue and profits growth that allows for enough dividend growth (assuming pay-out levels are held) to keep pace with the share price rise to date.

This situation may not continue. Share prices could rally without consensus dividends tagging along, thus depressing the yield. The advantage with dividends, however, is that your yield is based on your entry price and not the market price. Once you’re in, your yield is locked in. So if the forecast yield starts falling amid a share price rally, your yield holds firm. If anything you benefit two-fold with an accompanying capital gain as the shares rise.

Sure, the shares can also fall and the market yield rise. Dividends can also be reduced and even cut. If anything, however, this offers an opportunity to buy more, locking in the new higher implied yield to increase your average. After all when share prices fall sharply, the last thing management wants to do is reduce or even worse cut the dividend. That income tends to be the one thing keeping loyal shareholders on-board, preventing the shares from being dumped and the price from falling further. A form of downside protection if you like. While you wait in hope for the shares to recover.

If you like what you’ve read today and want to receive Accendo’s research permanently, get access here to bolster you market knowledge and help you make better investment and trading decisions.

As always – have a good weekend.

Mike van Dulken, Head of Research, 10 Feb 2017.