Why do several near monopolies pay decent dividends?

[TheMotorcycleBoy]

Hi all,

Mel and I are fairly new to investing, and after buying a few stocks, bonds and the odd fund, are thinking more about how companies perform etc. What we are currently puzzled about is what incentivizes firms such as Severn Trent Water and National Grid to pay out pretty reasonable dividends; 3.5% - 5.5% being the kinds of dividend yields we see being quoted.

Our very limited understanding of publicly listed companies informs us that small companies usually pay small dividends since they re-invest much of their profit back into the business. The concept there being that the shareholder is "rewarded" hopefully by the share price rising in accord with the value/size of the firm as it grows and prospers.

When companies get to a certain size, their growth phase seems to decelerate and then (in my naive opinion) they seem to pay dividends to keep the owners happy. Typically they are incentivized to do this since if they don't the shareholders will lose interest and sell up, the share price will fall, and the firm then is liable for a takeover. Certainly, in my experience (I work in a big US tech chip making firm) we see this happening all the time, that is, attempts by the board to keep the shareholders happy (good dividend yields being one such) in order to the price up and hence the wolves at bay.

So what motivates UK firms like Severn Trent and NG to pay out dividends? They seem in little danger of a hostile takeover.....they both exist as monopolies in each sector, and hence there is no one there to threaten their position of dominance.

Forgive our naivety, if we have forgotten a crucial point, but are generally puzzled as to the above observations, and wonder if any of you can shed any light on them.

thanks Matt

[Dod101]

I think to some extent you have answered your own question but for monopolies like the water companies for instance, they are heavily regulated thus removing much of the ability of these monopolies to exploit their position by hiking prices, and they also have a limited opportunity to grow say like Unilever. They have to reinvest in their business. Shareholders thus need to be compensated for the lack of real growth opportunities by a decent dividend otherwise there is little to attract them. This lack of real growth means that most of the return is via the dividend and so the market assigns to them a higher yield. All this could probably be expressed better but I hope you get the drift.

In other words, to take Unilever again, the world is its oyster but not so with say a water company which has a limited geographical area assigned to it and what the regulator would call 'excess profits' go to reduce prices rather than to the shareholders.

HTH

Dod

[TheMotorcycleBoy]

This lack of real growth means that most of the return is via the dividend and so the market assigns to them a higher yield.

Yes.

I was just speaking to a colleague and he says that another compelling reason for the dividend generosity is since (as you've said) the firms cannot reward with growth, they need to satisfy the shareholders somehow.

I replied but "what's in it for them?" "why not keep the money?". He said, otherwise, big investors will club together and fire the directors, qualifying his remark that a lot of these people (investors) will be big funds (e.g. pensions) who will rely on the predictable dividends from utilities to form the safer base of the equity side of their portfolios.

Matt

[Urbandreamer]

When companies get to a certain size, their growth phase seems to decelerate and then (in my naive opinion) they seem to pay dividends to keep the owners happy. Typically they are incentivized to do this since if they don't the shareholders will lose interest and sell up,

I think that you have missed a couple of concept here.

As you recognise companies are OWNED by the likes of you and me. The board is responsible to run the company in the best interests of it's owners and return what profits that it can to them if the company can not invest the money to increase profits.

This gets interesting when it comes to companies that suffer political/geopolitical risk or regulation.

For example you may be aware of occaisional political hoo-har about the profits SSE et-al make, or the costs of electricity. You may have heared talk of re-nationalising the utilitys.
You may also be aware of reports in the press that it's getting increasingly difficult to keep the lights on. Again, reports about the risks of low generation on days without wind.

SSE have permission to build a pumped storage facility that would reduce the risk of demand exceeding supply on days with low wind, however what would the likely return to it's owners be? Unless it can see a profit in building and running the facility, why do it? Indeed why not simply give the money that it could use for that to its owners so that they can use the money better?

SSE are NOT building that pumped storage facility and Centrica are NOT replacing the gas storage facility that reached the end of its life as there would be no return on investment.

As you mention Seven Trent and National Grid, what investments could they make that provide a return to their owners? Well of course they could invest overseas in areas where there is a requirment for increased waster supply and electricity/gas infrastructure. Indeed thay have both done so.

The likes of SSE and Centrica have not diversified their political risks while Seven Trent and National grid have. That means that people must be offered a higher yeild to convince them to accept those risks. It also means that the likes of SSE and Centrica have less options of what to do with the profits that they make.

[TheMotorcycleBoy]

SSE are NOT building that pumped storage facility and Centrica are NOT replacing the gas storage facility that reached the end of its life as there would be no return on investment

Wow. Had not seen SSE's financials before. 4-traders is showing that they indeed pay stonking dividends.

Kind of upset we didn't investigate them earlier.

But perhaps as you allude:

The likes of SSE and Centrica have not diversified their political risks while Seven Trent and National grid have.

such an investment bears a future risk?

[Dod101]

Urbandreamer is writing of Severn Trent of course not Seven Trent but that is by the by. I am not sure his explanation about SSE and Centrica is entirely true and I think the owners of these utilities are better seen as the suppliers of capital because as I said, unlike say Unilever, to continue with that example, utilities cannot act as entrepreneurs. They are heavily regulated and so is the amount of profit they are allowed to generate. The regulator will make sure that if they are in danger of producing more profit than they can invest, it will go back to the consumers/customers, once the agreed level of return to shareholders has been reached. Furthermore just because there may not be a profit in a particular investment they may be obliged to invest if it is in the interests of the future of the electricity or water supply..

So to go back to your original question, I think it is a balancing act firstly in ensuring that the long term infrastructure is in place, that shareholders are adequately (but not over) rewarded for the capital they have supplied, and that customers are charged enough (but only enough) to generate sufficient funds after all expenses to meet these two aims. Capital gains in the share price is not a priority in that environment so it really comes down to dividends. Apart from the threat of political interference (the price cap or even nationalisation) that is why they are seen as good income shares.

Inevitably some of these posts are crossing each other but I hope this still makes sense.

Dod

[tjh290633]

If you can remember that far back, water companies were either municipal bodies or were companies with fixed interest stock, rather than ordinary shares. River boards were also in the statutory undertaking category. Nationalisation brought them together and then privatisation led to the present situation plus the Environment Agency looking after the water courses.

The water companies are more quasi-bond in nature, mainly because of the way in which they are regulated. Much the same applies to the other utilities.

TJH

[Alaric]

The water companies are more quasi-bond in nature, mainly because of the way in which they are regulated. Much the same applies to the other utilities.

Up to a point you can compare utility shares to retail bonds as the returns can be similar. With shares as always there's a greater risk of losing some or all of your capital but with higher dividends and potential for price growth as compensation. Indexed retail bonds don't exist in any quantity, utility shares might be the next best thing.

Another way of looking at utilities is that you buy enough so that the dividend pays your water, gas or electricity bills. So when you lose as a consumer when the price goes up, you gain as a shareholder with an increased dividend.

[odysseus2000]

Utilities in the UK were once nationalised, returned to the private sector in the Thatcher years. It soon became apparent that these private bodies could charge what ever they wanted as folk had to have their services.

Voters didn’t like this and so the government introduced regulators whose job is to limit what a utility charges consistent with it making enough profit to maintain the infrastructure and then the political point of enough of a dividend to provide income for investors. The latter generally transfers money from poor folk who generally don’t own equities and gives it to rich folk who often do own equities. This could change in different political regimes or the utility could be re-nationalised.

Within this structure exists management who are often well paid and have a easy life if they bow to the regulator and maintain services to the punters. They know that any competitor who wants to buy them will also be regulated so there is no point trying very hard to grow the business in other ways and anyway if there is a bid they will usually do well out of it. If not they live well. The other case is that if they invested more they might be able to bring the cost of supplying their commodity down, but as they are regulated unless they can hide their cost reductions, the regulator will reduce their prices, so why bother. Buffett regularly contrasts the price of power in states around him, noting how the private utilities offer much cheaper power as they have invested in renewables, mostly wind etc.

However, some managers are not satisfied with this regime and seek other opportunities, either abroad or by offering additional, preferably none regulated services, using e.g. the land they have to carry fibre, cell tower masts, selling their engineering expertise via consultation etc…

Meanwhile the world is endlessly chatging and new opportunities emerge. It seems clear, at least to me, that cars will go electric and that will require more charing points, more cables and a likely continued requirement for more renewable power. This should be a huge opportunity for National Grid along with the other generators, very like when e.g. domestic houses started to get fridges, cookers, TV etc.

UK utilities in my opinion have so far failed to understand how to profit from the increased use of electricity, while at the same time the US tech giants have grasped the nettle and have gone for renewables in a huge way. Apple recently announced that their entire business is powered by renewables and although one might think this is just marketing there is a large business case as by controlling their own power they are not hostage to regulators and utilities raising prices and the expertise they have in powering themselves can be used to develop competitors for existing utilities, plus they can sell excess power. I expect new entrants to the utilities market offering lower prices and 100 % renewable power as it is a cost leader, i.e. costs less than conventional fossil or nuclear generation. If this happens the existing utilities will be pressured and in a bit of pickle.

One can argue that water is the only utility that is immune to potential competitive pressures, but even here there is the possibility of a competitor coming in and building a lot of micro-scale reservoirs which would mitigate flood risk and potentially offer lower cost water to suppliers.

The utilities industry may sail on as it is or may be substantially different going forwards. In the meantime investors will pick up a good return but may see the equity price decline or stay low if the prospect of a Corbyn administration begins to look possible or if the potential threat of new competitors emerges.

Regards,

[TheMotorcycleBoy]

Thanks very much, Odysseus, nice post.

I expect new entrants to the utilities market offering lower prices and 100 % renewable power as it is a cost leader, i.e. costs less than conventional fossil or nuclear generation. If this happens the existing utilities will be pressured and in a bit of pickle.

I guess for National Grid, they have a more unique position than being "just a generator" since they also own the entire distribution network, I do believe:

https://www.nationalgrid.com/uk/about-g ... and-assets

[Urbandreamer]

I guess for National Grid, they have a more unique position than being "just a generator" since they also own the entire distribution network, I do believe:

https://www.nationalgrid.com/uk/about-g ... and-assets

Actually, from your link, they don't!

To quote the link "We own the electricity transmission system in England and Wales".

Who do you think owns the one in Scottland?
I'll give you a clue.
http://sse.com/whatwedo/networks/electr ... tribution/

I've held SSE since the days of "Tell Sid" and have a favourable opinion of their business and managment. That said they carry significant political risk and have droped a few clangers with regard to selling electricity to the public.
Recently they are trying to split off that side of their business, but the Competition and Markets Authority is not impressed.

https://www.theguardian.com/business/20 ... s-watchdog

FWIW, I think that the CMA are right to be concerned. As a SSE share holder I would like to see them exit that part of the market and I suspect that this move was intended to allow SSE and N-Power to simple get out of that business and hence cease to be political footballs.

[Dod101]

More on SSE. They are responsible for transmission cables (the things strung between the pylons and sometimes underground) for the North of Scotland, roughly Perth and north, Scottish Power for the rest. I too like SSE and its management is quite pragmatic in its outlook. Arising presumably from their early foray in to renewables, hydro electric, they are quite big in wind power and other renewables. They also love the subsidy from the UK Government.

However apart from owning Southern Electric and maybe one or two other minor things, they are almost entirely Scottish and currently run the entire ship from generation and transmission to retailing electricity and gas and thus are absolutely in line for nationalisation without the complications of National Grid with its North American interests. SSE's finances are also rather stretched. On account of these factors I reduced my rather large holding during 2017.

Dod

[TheMotorcycleBoy]

I guess for National Grid, they have a more unique position than being "just a generator" since they also own the entire distribution network, I do believe:

https://www.nationalgrid.com/uk/about-g ... and-assets

Actually, from your link, they don't!

To quote the link "We own the electricity transmission system in England and Wales".

Ok, fair enough. However setting aside the land mass north of the border....

However, they (NG) still seem to (as just England is concerned) that a different position (indeed unique) to that of a firm, e.g. a solar farm, that is responsible for a portion of generation, but not for the upkeep of the grid that supplies customers with their product. That was my point. Feebly researched as it was!

IOW no matter how innovative an independent generating firm may be, it is still the NG who (currently) manage the infrastructure, and by that token reap the benefits due to that. A bit like a landlord?

[TUK020]

It's more complicated than that, I am afraid.

Physical infrastructure can be divided into:
- generating plant
- grid level connection ( a further level of complexity is that this can be divided into physical interconnect, and the supply/demand management)
- local distribution network operators (DNOs)
On top of that, retail suppliers buy capacity from generators, get it moved to their bit of the country by the grid, sell to retail customers, and pay DNOs to maintain the local substation and wire to the house.

Grid is run by NG in England and Wales, and by SSE in Scotland
GB is divided into 14 regional DNOs, who are owned by companies like UKPN, WPD, SSE, Scottish Power.

So SSE for example, owns some generating capacity, some grid, some DNOs and some retail selling.
Most of the main players are involved in multiple bits, although with different emphasis...........

Sorry you asked?

[TheMotorcycleBoy]

Sorry you asked?

Ha! Not in the least.

Anyway my point (?) is still approximately valid: NG for England+Wales, and SSE for Scotland, currently have a slightly different position than a new innovative firm that cheaply generates.

See this recent offshoot of the OP all stems from my reply to this quote:

I expect new entrants to the utilities market offering lower prices and 100 % renewable power as it is a cost leader, i.e. costs less than conventional fossil or nuclear generation. If this happens the existing utilities will be pressured and in a bit of pickle.

from this earlier post
viewtopic.php?p=136195#p136195

i.e. I'm guessing that NG and SSE will still have a somewhat advantageous position, before some horrid Robin Hood comes along and gate crashes their party.

[TheMotorcycleBoy]

We are now wondering about buying some SSE shares.

At 6% dividend yield it looks worth a go. What are the risks? Are they political....i.e. Corbyn or Nicola Sturgeon will come along and break up / or force changes on the company, and the share price will plummet, i.e. meaning the base capital value of our stock that the dividend applies becomes drastically reduced?

thanks
Matt and Mel

[tjh290633]

The immediate question about SSE is the proposed merging of its retail side with that of nPower. If that goes through you will have two holdings, and you might prefer to hold one or the other or both.

I would be inclined to wait until the situation is clearer. I hold SSE and would not wish to add more until I knew more about the future scene.

TJH

[odysseus2000]

Melanie

We are now wondering about buying some SSE shares.

At 6% dividend yield it looks worth a go. What are the risks? Are they political....i.e. Corbyn or Nicola Sturgeon will come along and break up / or force changes on the company, and the share price will plummet, i.e. meaning the base capital value of our stock that the dividend applies becomes drastically reduced?

thanks
Matt and Mel

What are your investment objectives?

How do you see shares fitting into your investment plan?

Are you just interested in the dividend yield?

Do you think sse is very cheap & you want to buy it with the idea of taking a capital gain on a re-rating & meanwhile collect a good divi?

If sse tanks would you sell or buy more?

You have to decide what interests & what fits with your overall investment thesis & what % of your net worth you want in equities.

But these are difficult questions & some people just decide they want equities & buy them with out further considerations with neither an add more or an exit plan.

Sometimes that works well, sometimes it doesn't.

No poster can answer these types of questions.

Specific questions of a very well defined nature might get a good answer or might not.

If your going to invest/trade equities you have to do what you think is right & adjust as necessary.

Individual equities are very very hard & I advise folk to do other things like buy property, start a business, if you still want equities find an approach that suits your personality & if it gives you losses or other negative things, try some other approach & always remember that what works now will almost certainly not work in the future & then may work again. As I said equities are hard.

Regards,

[TheMotorcycleBoy]

Melanie

We are now wondering about buying some SSE shares.

At 6% dividend yield it looks worth a go. What are the risks? Are they political...

What are your investment objectives?

How do you see shares fitting into your investment plan?

Are you just interested in the dividend yield?

Do you think sse is very cheap & you want to buy it with the idea of taking a capital gain on a re-rating & meanwhile collect a good divi?

If sse tanks would you sell or buy more?

You have to decide what interests & what fits with your overall investment thesis & what % of your net worth you want in equities.

But these are difficult questions & some people just decide they want equities & buy them with out further considerations with neither an add more or an exit plan.

Sometimes that works well, sometimes it doesn't.

No poster can answer these types of questions.

Specific questions of a very well defined nature might get a good answer or might not.

If your going to invest/trade equities you have to do what you think is right & adjust as necessary.

Individual equities are very very hard & I advise folk to do other things like buy property, start a business, if you still want equities find an approach that suits your personality & if it gives you losses or other negative things, try some other approach & always remember that what works now will almost certainly not work in the future & then may work again. As I said equities are hard.

Regards,

Thanks for your reply,

I appreciate that my questions were a little fast and loose! But we have only started investing recently and are still learning....plus our attitude to questions per se. to just to ask, and accept that you can get all kinds of answers back. Nothing ventured nothing gained.

Our objectives re. investment is to provide a more independent and diverse way to deal with our savings. We both have some pension schemes which have slowly built up over the past couple of decades, and as we acquire about 5k extra a year, and shed our mortgage some years back, we have accumulated about 35k to slowly invest. We do have some time and inclination to research, have a "medium risk" perspective, etc. on things in general.

We see shares as maybe having 50-60% or so of our portfolio. And giving the recent history of the stock market (well the dot com bubble), we are slightly more inclined towards dividend accumulation, than capital gain. Currently we have about 12k in a few individual UK stocks and some in the Fidelity World Index fund. We would like to invest the remainder in bonds + gilts, but are skeptical as to whether now is the best time to buy - to date we have a couple of k in junk-type corps bonds (@5.5% yield) and a couple in slightly safer looking Tesco and BT offerings (@3%).

We are of the mindset that if one of our stocks tanks, we'd just leave it, and only consider re-buying if it looks set to recover. We wouldn't sell at a loss though.

The immediate question about SSE is the proposed merging of its retail side with that of nPower. If that goes through you will have two holdings, and you might prefer to hold one or the other or both.

I would be inclined to wait until the situation is clearer. I hold SSE and would not wish to add more until I knew more about the future scene.

TJH

Anyway, I'll leave my post at this for now. Just wanted to get more of a handle on SSE. What everyone has added so far, has been helpful.

thanks M&M

[odysseus2000]

I appreciate that my questions were a little fast and loose! But we have only started investing recently and are still learning....plus our attitude to questions per se. to just to ask, and accept that you can get all kinds of answers back. Nothing ventured nothing gained.

Our objectives re. investment is to provide a more independent and diverse way to deal with our savings. We both have some pension schemes which have slowly built up over the past couple of decades, and as we acquire about 5k extra a year, and shed our mortgage some years back, we have accumulated about 35k to slowly invest. We do have some time and inclination to research, have a "medium risk" perspective, etc. on things in general.

We see shares as maybe having 50-60% or so of our portfolio. And giving the recent history of the stock market (well the dot com bubble), we are slightly more inclined towards dividend accumulation, than capital gain. Currently we have about 12k in a few individual UK stocks and some in the Fidelity World Index fund. We would like to invest the remainder in bonds + gilts, but are skeptical as to whether now is the best time to buy - to date we have a couple of k in junk-type corps bonds (@5.5% yield) and a couple in slightly safer looking Tesco and BT offerings (@3%).

We are of the mindset that if one of our stocks tanks, we'd just leave it, and only consider re-buying if it looks set to recover. We wouldn't sell at a loss though.

Hi Melanie,

Given what you have typed, you might find some interesting stuff on the Lemon "High Yield Portfolio (Practical)" board which is tailored towards dividends.

Good Luck!