If youre looking for dividend income from your portfolio, then the higher the yield the better, yes?
Banco Santander (LSE: BNC) (NYSE: SAN.US) paid a staggering 9.7% in 2012 and 8.8% in 2013, so that really must be good news? Actually, no. But before I tell you why I think not, lets have a look at Santanders dividend situation:
Magnificent yields, and if you could continue to get those levels of cash from now until you retire in 10, 20, or however many years time, youd be coining it.
But yields like that are simply not sustainable over anything other than the very short term, because the bank just is not earning enough cash to keep paying them. Years of plummeting earnings meant that earnings per share could only contribute less than 40% towards the dividend paid in 2012!
And 2012 completed a few years of declining share prices too, as investors could clearly see the writing on the wall over five years the Santander share price is down nearly 40% while the FTSE 100 is up 40%. But it has recovered a little since mid-2012, and today stands at 600p.
So how did Santander manage to maintain those uncovered earnings?
Its because a very large number of Santander shareholders have traditionally chosen to take their dividends as scrip so the company only has to issue new shares and doesnt actually have to stump up the cash.
But too much of a scrip take-up can be damaging in the long term, for two reasons.
Firstly, the increasing number of shares in issue dilutes the value of existing shares, and as every year the companys profits are split between more and more shares, earnings per share falls. If you take excessive returns this year in the form of scrip, youre setting yourself up for future years of lower per-share rewards.
But what if you just take the cash? Well, thats exactly what a very high yield will attract a lot of people to they see 9% dividends being taken as scrip and think Blow that, Im having the cash. But as more people are attracted to the cash option, the harder it becomes for the company to actually come up with the folding stuff.
And were seeing the results, with Santanders dividends set to fall.
But as I suggested, thats a good thing. It should mean Santander will move towards a more sustainable dividend model, equitable to both takers of cash and scrip, with the annual yield moving towards levels that are comfortably covered by earnings.
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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.