Warning bells are ringing - global profits surge but dividends are skyrocketing even faster

With all this economic doom and gloom, how are corporates doing so well? And should we be concerned?

Article updated: 17 October 2019 10:00am Author: Michael Baxter

I have a puzzle this morning. Here is my question to you, why? Here is is another, how is this possible? According to a report from Henderson International Income Trust, between 2010 and 2018, global profits increased by an annual average of 6.5 per cent. Why is this? And how is this possible, given that growth in the global economy has been much slower?

The Henderson report focused on dividend cover, which is the ratio of net profits to dividends.

It turns out that during the same period, global dividends increased by 10.3 per cent a year.

In 2018, global profits increased 7.2 per cent and are expected to rise by a similar amount in 2019. Given that there is all this economic doom and gloom out there at the moment, how is it corporates seem to be doing so well?

As for dividends, they increased 9.2 per cent last year and are expected to increase 8.7 per cent this year.

And if you like numbers with lots of noughts on the end, you may be interested to read that global dividends in 2018 hit £1,000,000,000,000, or one trillion pounds. Why, that’s even more money than Jeff Bezos has got.

It turns out that back in 2010, global profits were three times dividends. In 2018, however, profits were 2.3 times dividends.

Stop there. That ratio doesn’t seem too bad to me.

Warning bells ring, at least I think that’s what I can hear, maybe it’s the church bells down the road, because in Australia profits were just 1.4 times dividends. In Blighty, which is third from bottom in the dividend cover league table, profits are 1.6 times dividends.

Why is this ratio so low? The Henderson report stated: “The deeply entrenched dividend culture in the UK combines with a sector mix that is dominated by large oil and pharmaceutical companies, as well as banks and utilities, all mature, high-payout sectors.”

At the other end of the league table, in the equivalent of the Liverpool/Manchester City slot, you have South Korea, where profits are four times dividends. China is just behind.

I was originally going to speculate that this low level of dividend cover explains the UK’s low level of productivity, as companies are paying dividends instead of investing, but then I spotted that sitting in number three in the dividend league table, with a healthy ratio of profits to dividends of 3.1, is Japan, which has even lower productivity than the UK.

Why are dividends growing faster than profits? Henderson said: “This dividend growth reflects a number of factors, including the normalisation post the stresses of the crisis, balance sheet rehabilitation, lower debt costs and investor appetite for income.”

According to a report by the IMF out this week, corporate debt has now reached $19 trillion, with 40 per cent of this debt in the US, China, Japan, Germany, Britain, France, Italy and Spain.

The IMF warned that this debt would be impossible to sustain in the event of a global downturn half as bad as the 2008 downturn. I wonder, by the way, whether the IMF has got this argument back to front. If corporate debt proves unsustainable, it may trigger the next downturn.

The IMF also warned investors against being lured in by the appeal of companies that appear to offer high returns.

“They encourage investors to take more chances in a quest for higher returns, so risks to financial stability and growth remain high in the medium term," it said.

I am tempted to say that the decreasing level of dividend cover is related to the rising debt levels, but it is curious that China has a good ratio of profits to dividends but a massive corporate debt problem in the making.

So, is that really warning bells I can hear, or are my ears deceiving me? Over to you.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.