Like the UK economy, dividends paid by UK companies to shareholders are firmly in recovery mode. Last week, wealth management platform AJ Bell predicted that dividend payments from the top 100 companies listed on the UK stock market would rise 25% this year to just under £ 77 billion.

While the rebound is admittedly after last year’s dividend decimation caused by the economic fallout from the pandemic, it will be warmly greeted by an army of private investors who depend on income to bolster their household finances.

If AJ Bell’s financial crystal ball watchers are correct, that should mean that the FTSE100 index as a whole will generate annual income equivalent to around four percent this year – a rate not available for most other assets. financial, especially cash where savers are lucky. if they can get an annual return of 0.01 percent.

In addition, AJ Bell estimates that the dividend recovery will continue next year, albeit at a slower pace (2.2%).

So, all the good news? Well not really. If you dig a little deeper into the wealth management platform’s analysis, you’ll soon find that much of this year’s dividend increase will come from just ten companies.

These include a group of big banks – Barclays, HSBC, NatWest and Lloyds – which the city regulator relied on last year to stop paying dividends as the pandemic raged and the economy was teetering on the brink of disaster. Among the ten are also the mining giants Anglo American, BHP, Glencore and Rio Tinto. The list is completed by BT and home builder Persimmon.

While many investors will be comfortable owning some of these large, income-friendly stocks, a growing number will be more selective due to ethical considerations. The increased focus on environmental, social and corporate governance (ESG) issues means that many investors now shy away from “sinful†stocks – regardless of the juicy carrots of dividends hanging before their eyes.

Although “sin†is a subjective term when used in investment circles, “sin†stocks tend to include mining companies (including the four just mentioned); oil and gas companies (like BP and Shell); and companies involved in either the manufacture of cigarettes (Imperial Brands and British American Tobacco) or alcohol (Diageo). All are in favor of dividends.

Indeed, last week, Shell confirmed its intention to give more liquidity to its shareholders following its decision last year to reduce its dividend by two thirds.

Dan Lane, senior analyst at Freetrade, the equity trading department, says the link between “sinful†stocks and attractive dividends poses a dilemma for ESG-conscious income investors.

He says, “With the FTSE100 full of big pharmaceutical, mining and arms companies and vices like tobacco and alcohol, matching your morale with your money is easier said than done. Especially given that some of the less “sustainable” companies pay some of the highest dividends. ”

Some of the big companies that are expected to pay dividends this year, equivalent to an annual rate (yield) of seven percent, include “sin†stocks Anglo American, BAT, BHP, Imperial Brands and Rio Tinto.

“Is it even possible to get income outside of the sectors of sin?” Lane asks. Well, it does, even if it means investors will be more pragmatic in terms of how much income they expect from their stocks. A little less income now, in the hope of increasing income in the future.

Andy Marsh is the co-manager of Artemis Income, a £ 4.8 billion fund popular with income-seeking investors. It currently generates an aggregate income equivalent to about four percent per year.

To do so, the fund holds dividend-friendly stocks in its portfolio of 47 stocks, such as Anglo American and BP, as well as Barclays – which is expected to be one of the biggest dividend payers in the market this year. It is also exposed to some large “returns” such as Legal & General (seven percent) and Direct Line (eight percent). Yet a key part of Marsh’s overall investment strategy is to identify UK companies that pay a modest dividend (between two and three percent per annum), but offer the prospect of sustained dividend growth over the years. next three to five years.

“As a fund manager, cash flow is critical when it comes to finding companies that will provide shareholders with sustainable income,†says Marsh.

“We want to make sure that a business will have enough cash flow to pay dividends once it pays all of its bills and makes all the necessary investments in its business to protect and grow it. Strong cash flow generates strong dividends. But if a company’s cash flow seems compromised, red lights flash. It’s a signal that a dividend shock could be around the corner.

Marsh says Relx and the London Stock Exchange are good examples of companies backed by good cash flow.

He says: “Although both have roots dating back to the 19th century, they have turned – unnoticed to many – into the new economy. They are profitable, growing, forward-looking and the dividends they pay appear to be sustainable. They also tick all the boxes when it comes to ESG investors. ‘

The FTSE100 Relx company, he says, has embraced the technology to digitize its publishing business. Meanwhile, LSE, also listed on FTSE100, derives 70% of its revenue from subscriptions built around its data and analytics.

“The digitization of financial market data is still in its infancy,†Marsh adds. “This presents a long-term opportunity as demand increases from banks, wealth managers and asset managers. Relx increased its dividend last year by just under 3% and is currently offering a dividend yield equivalent to around 2.4%. The London Stock Exchange increased its dividend by seven percent last year, with Marsh predicting “double-digit growth” over the next three to five years.

These two companies are on the AJ Bell list of FTSE100 companies that have increased their dividends every year for the past decade (see table). Last year, that list had 24 members, but it’s now down to just 15.

Russ Mold, chief investment officer at AJ Bell, says many of these companies don’t offer dividends that, in terms of returns, will kick the pulse of income investors. But he says investors shouldn’t be put off.

Mold adds, “History suggests that it is not the most profitable stocks that turn out to be the best long-term investments. Standing up for high yield can become a burden on a business, and the strongest long-term performance often comes from companies with the best records of long-term dividend growth. ‘

As an example, he cites safety equipment maker Halma, who is one of the 15 “dividend aristocrats†listed in the table. It has increased its dividends in each of the past 42 years, still by at least five percent. Last year the dividend stood at 17.65 pence per share, an increase of 7% from the previous year. With a share price above £ 27, the dividends are equivalent to a yield of just 0.6%. Mold said: “Halma’s share price was 1.9 pence at the start of 1979 when her dividend growth streak began. So the expected dividend of 18.5 pence this year looks pretty good compared to that.

“Its current share price represents an astonishing return on capital over the past 40 years and shows how well-run, well-funded companies can reward truly patient investors – with a combination of capital gains and revenue growth. . “

AND DON’T FORGET INVESTMENT TRUSTS

Among the “dividend aristocrats†of AJ Bell’s FTSE100 is Scottish Mortgage, the country’s largest investment trust.

Managed by Edinburgh-based Baillie Gifford, it has recorded 39 years of dividend growth, although this aspect of its investment arsenal often goes unnoticed by interested investors due to its extraordinary investment record.

Over the past year, its stock price has risen nearly 44% – 144% over three years.

Yet Scottish Mortgage is not the only publicly traded investment trust to have recorded sustained dividend growth. He is one of 18 who have grown their income to shareholders for at least 20 years. At the top of the tree are Alliance, Bankers, Caledonia and City of London who have all increased their dividends for 54 years.

A LAST THOUGHT ON SIN STOCKS AND INCOME

Investment expert Rachel Winter believes investors shouldn’t automatically snub all “sinful†stocks when seeking income. She says many such companies are striving to change the focus of their operations to become more environmentally friendly.

Others are involved in industries that provide the materials needed to reduce global dependence on fossil fuels.

Winter, managing partner of stockbroker Killik, says, “Yes, tobacco companies are securities, but it all gets a little more subjective when you look at other businesses like mining. Take Rio Tinto, for example. Yes, it has been involved in big environmental controversies, but thanks to its copper mining it plays a key role in facilitating the growth of the environmentally friendly electric car.

Likewise, while BP and Shell are still dependent on oil production, they have laid out plans to become net zero emissions companies by 2050. ”

Winter’s preferred green income stock is energy supplier SSE, which is building the world’s largest offshore wind farm at Dogger Bank in the North Sea. Its dividend is equivalent to more than five percent per year.