Financial Times - Never let a crisis go to waste

by Terry Smith | Apr 30, 2020
  • financial_times_md

We now have a fully-fledged economic crisis caused by the reaction to the Covid-19 pandemic. What should you do about it in terms of investment?

I would strongly advise avoiding the approach of many investment advisers or analysts. They spend their time speculating about what will happen. When will the lockdowns end? What will happen in the travel and hospitality industry? When will there be a vaccine (I suspect that question should be “Will there ever be an effective vaccine?”). Who will be the winners — makers of disinfectant and masks? Drug companies? E-commerce plays? Home food delivery?

In my view, all of this speculation is useless. No one knows. It is about as useful as all those “risk registers” which companies are required to produce, demonstrating that they have assessed the main risks to their business. How many of them do you suppose had “pandemic” listed prior to these events? Equally, how many will omit it in future? It is not only generals who are prone to fighting the last war.

My award for the silliest question asked by an analyst so far goes to the questioner who asked a US company presenting its quarterly results: “What would cause your device sales to be down in the second quarter?” (I’m not making this up.)

But as an old saying goes, “Never let a crisis go to waste.” You should always think about a crisis as an opportunity. This was expressed in the notorious remarks of a spin-doctor working for Stephen Byers, the former transport secretary, who wrote of 9/11, “It’s now a very good day to get out anything we want to bury.”

We can already see this advice being followed. The Investment Association has suspended its equity income requirements for 12 months. This is bad news for equity income investors. It’s not as if these requirements were exactly stringent to begin with.

To qualify for inclusion in the IA UK Equity Income sector, all a fund had to do was exceed 90 per cent of the yield on the FTSE All-Share Index each year (not a mistype — yes, a fund yielding nearly 10 per cent less than the index qualified as an income fund) and exceed the index yield on a three-year rolling basis.

In a ridiculous piece of deception, which I suspect would not be permitted in any other product, a fund can lose its Investment Association status and still carry the word “income” in its title. To paraphrase a common saying, “It doesn’t do what it says on the tin.”

To some extent the Investment Association is just acknowledging reality. By mid-April a quarter of the stocks in the Stoxx Europe 600 Index had suspended their dividends.

However, I suspect that the really bad news for equity income investors is yet to surface. As at mid-April, the dividend cover on the top 20 highest dividend yield stocks in the FTSE 100 was just 1.3 times. For the top 20 largest absolute dividend paying stocks in the UK it was 1.1 times — net profits are just 10 per cent more than the dividend.

One of the more ridiculous questions which investors and others have been asking in this crisis is, “When do you think things will get back to normal?” This ignores the fact that what came before the crisis may not have been normal.

Over time, dividend cover for most businesses cannot be sustained at 1.1-1.3 times, as most of them need retained earnings in order to grow. An average cover of two times is more normal. I would suspect that the boards of companies which have passed the dividend will indeed not be allowing a good crisis to go to waste and will return with a much smaller and more sustainable dividend which will mean much lower yields for equity income investors.

I have long said that no one should invest in equities for income. If you had invested in the IA UK Equity Income sector over the past five years, you would on average have lost nearly 1.3 per cent a year. The best way to approach this is to invest for the highest total return you can achieve and sell whatever shares or units you need to provide cash. However, I realise that for many investors, the idea of realising part of their capital to provide income is anathema. So what to do?

If you insist on investing for dividend income, consider investing alongside a family which founded and has control of a public company. Out of the 47 stocks in the Stoxx Europe 600 that are “family influenced”, only three have cancelled or postponed dividends. Very often these extended families, descended from the business founder, rely on the dividend income from the family business.

The chief executive of one of the family controlled companies we invest in at Fundsmith says his first piece of advice from the patriarch of the family was to never cut the dividend. Investing alongside them can help to preserve your income too, and in this market environment you may get some attractive opportunities to do so.