European companies are paying out the highest proportion of their earnings as dividends in more than 40 years, stoking fears among analysts over whether such payouts are sustainable. Investors have long grappled with the question of what companies should do with mounting cash loads - return it to shareholders or spend it on technology, research and development, top staff or even bolting on new businesses for future growth.
For the past five years income-hungry investors have welcomed dividends from European firms. Payouts have provided an antidote to the combination of sluggish economic growth, aggressive central bank policy easing that has pushed bond yields to record lows and choppy stock markets. But the growing disconnect between earnings and dividends and worries that companies may be adding debt to fund the shortfall is spurring a reassessment of this thesis.
"We're seeing a lot of companies trapped into their dividend policy," said Julien Jarmoszko, senior research manager at S&P Global Market Intelligence. Nearly 60 percent of Europe Inc's earnings per share are returned to shareholders as dividends, according to Thomson Reuters data. Companies' bias for dividends is in no small part fuelled by investors urging companies to part with cash because of limited opportunities for capital spending.
But a shift is underway. In one warning sign to companies borrowing to fund buybacks and dividends, last month's Bank of America-Merrill Lynch survey of global fund managers suggested investors may stop rewarding capital returns to the same degree as before. The net percentage of fund managers saying payout ratios were "too high" was at the highest level since March 2009. Instead, fund managers are increasingly scouring for earnings and rewarding companies that are either ploughing back profits to expand their businesses or those that have cut payouts to protect balance sheets.
"We like companies that don't actually pay too much of their cash flow out because they have good opportunities to invest in fixed capital and generate higher returns in the future through these investments," Tim Crockford, lead manager of the Hermes Europe Ex-UK Equity Fund, said. Crockford singled out Spanish technology company Amadeus IT and German laboratory equipment company Sartorius as good examples. Amadeus, for instance, has spent money to invest in its IT business, making the firm's services more appealing to customers such as airlines.
Meanwhile, some commodity-related firms which have cut dividends as part of an effort to tackle the slump in metals prices have seen their share prices rally. Glencore, which lost more than half its value last year before suspending dividends in September, has gained 13 percent since then. BHP Billiton has gained 30 percent since cutting its dividend in February. This willingness to accept lower or no dividends in favour of leaner balance sheets marks a significant shift. Moreover it would signal to European firms that efforts to spend on themselves and get in front of a pickup in growth would be rewarded while a stubborn reliance on payouts would not.
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