Income stocks bulletin

Why income stocks give the portfolio ballast in gloomier markets

As a core holding, designed to work hard for generations of investors’ portfolios, Alliance Trust aims at providing both capital growth for your future financial goals and an income stream for your near-term spending needs.

As a result, the portfolio reflects the mandate: comprising companies that are growing and investing to become the cash-generative powerhouses of tomorrow, as well as other, more mature firms with sophisticated operations that are paying back investors today with dividends.

Currently, the global economic environment is somewhat grisly and may be for a little while longer. Inflation is being stoked on numerous fronts, such as high gas and food prices on account of Russia’s war on Ukraine. In response, central banks such as the Bank of England are raising interest rates, putting the brakes on economies, a squeeze on consumers, and a strain on company profits.  

Markets are reflecting the gloom and have been languishing this year. It means, in this environment of heightened volatility, companies that pay reliable dividends become attractive as they serve to provide the portfolio ballast. Here are four reasons why:

STOCKS FOR TRICKY TIMES

When the wider economic picture bears down on markets as recessions threaten earnings, stocks tend to fall in value as the tide goes out on investor sentiment. It makes capital returns unreliable at best. Dividends, on the other hand, tend to be far less volatile, with management teams retaining the option of dipping into cash reserves to top-up payouts if shortfalls in earnings emerge. It means in times of uncertainty the dividend component of the total return becomes ever more important – indeed, a bird in the hand is worth two in the bush.

Secondly, strong dividend-paying firms tend to have well-established operations and be of a higher quality ebb, with robust balance sheets that can withstand a tougher recessionary environment and rising costs. As a result, and broadly speaking, the volatility of their share prices tends to be lower than those of companies that do not pay dividends, with dividends acting as a buoyancy aid for valuations.

Thirdly, when inflation remains stubbornly high, income from stocks becomes a preferable source to income from bonds or savings accounts. Income from bonds tends to be a set rate of interest, and income from savings tends to be somewhat lacklustre in comparison to levels of inflation. Meanwhile, dividends are attractive because companies retain the ability to grow their earnings and therefore dividends in line with inflation by raising prices, albeit as long as they have sufficient pricing power – a feature that many of the stock pickers at Alliance Trust seek in their investments.

Finally, underlying dividends enable Alliance Trust to pay a rising level of income to investors which they may use to offset rising living costs or buy more shares – a fantastic source of returns over the long term. Moreover, Alliance Trust retains a well-stocked revenue reserve – an attractive feature of investment trusts – which enabled the Trust’s Board to increase its dividend last year by 32.5%, translating into a yield today of about 2.5%. It is how the Trust has managed to pay its investors consecutively rising dividends, year after year, for 55 years, and, given the many peaks and troughs of the market over that time, points to the intention of the Board to continue doing so even if we head into a recession. What is more, unlike many pure income mandates, if the predicted downturn is milder than economists forecast, strong capital growth may emerge and boost investors’ total return.

Marcus De Silva is a Freelance Investment Writer

This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at November 2022 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is the appointed Alternative Investment Fund Manager of Alliance Trust plc. Alliance Trust plc is a listed UK investment trust and is not authorised and regulated by the Financial Conduct Authority.