UBS tips dividend paying stocks ‘in favour’ as investors sell out of firms cutting payout

UBS says one factor could make or break this year’s trading for investors and has a list of stocks it thinks could do well.

UBS expects earnings to plunge 35pc this year, while dividends will fall 30pc, led by a 41pc drop in financial dividends

A scarcity of dividends will see cash-hungry investors flock to a select number of stocks in the coming months in what could be the most important trade of the year, according to investment bank UBS.

ASX-listed companies that pay out fully franked dividends will be in favour for the next three to six months, likely driving their share prices higher, while companies forced to cut or suspend dividends will be harder hit as investors sell out in favour of income stocks.

The “significant selling pressure” on companies forced to reduce or suspend dividends will come from three fronts: retail investors, institutions and systematic investors, such as ETFs, UBS head of quantitative research Paul Winter told The Australian.

“When a company suspends its dividend, if you need income your knee-jerk reaction is to sell the stock and buy a stock that is going to pay a dividend. So there tends to be retail selling,” he said.

“We model that behaviour, as quants, and as a result, quantitative funds tend to short stocks the minute they suspend dividends because it’s a great signal that they’re going to underperform.”

Alongside retail selling and quantitative shorts, some exchange-traded funds, such as income ETFs, will be forced to sell companies that suspend dividends because their rules state they can only invest in dividend-paying companies.

The final cohort is the institutional investor, which may also remove a stock if its mandate is to invest in high-yield companies.

“Today there is an enormous amount of capital held by retirees which is either invested directly in these high-quality dividend yielding stocks, or invested into those stocks through systematically rebalanced products (ETFs) or investment funds.

“Not all of this capital will flow out of those stocks. But there will be significant selling pressure of companies that suspend or reduce their dividends. And that money will flow into companies that can sustain the dividends or indeed grow their dividends.

“So we think that that will be the biggest trade in the market in the next three to six months,” Mr Winter said.

UBS expects earnings to plunge 35 per cent this year, while dividends will fall 30 per cent, led by a 41 per cent drop in financial dividends. Already, 38 ASX 200 stocks have suspended, deferred or cut dividends and a further 60 have seen dividend per share forecasts fall by more than 20 per cent.

Among the companies UBS tips will cut dividends are Alumina, ANZ, NAB, Northern Star, OZ Minerals, QBE, Servcorp, Stockland, Western Areas and Westpac. UBS’s preferred income stocks include Aurizon, Metcash, Coles, APA and Woolworths, and it expects the share prices of these companies to run up strongly from now through reporting season and until stocks go ex-dividend in September and October.

It also expects their share prices to drop by less than usual on their ex-dividend dates due the scarcity of income returns.

AGL, Amcor, Brambles, Inghams, Magellan, ResMed, Seven Group, Telstra and Wesfarmers are among those that will also provide reliable dividend streams this year. “We think the current environment will mean the opportunities related to dividends and franking will be even bigger in 2020 because the number of dividend events will be less than normal; there will be a scarcity of income returns,” UBS analyst Pieter Stoltz said.

The search for yield has seen income (dividends plus franking) drive 87 per cent of the total return of the ASX 200 in the past decade, with companies that paid out franked dividends tending to outperform the market, he said.

Amid expectations of a 35 per cent earnings hit due to the coronavirus, UBS sees further downward pressure ahead. “There’s a lot of stimulus-driven euphoria in the market right now. When we look across history, markets often have false starts during these significant downturns, especially during recessions,” Mr Stolz said.

He expected the S&P/ASX 200 to bottom just below 5000 in the coming months, but did not expect it to fall back to the 4500 level it reached in March.