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Super returns from Safe Yields

The Safe Yields stock screen produced a 22.2 per cent total return over the past year compared with 6.5 per cent from the FTSE All Share. We unearth nine more Safe Yield stocks.
July 23, 2014

The buoyant market conditions of recent years have helped many of my screens achieve exceptional returns, and my Safe Yields screen is another success story. But the strong market conditions are also increasingly presenting problems for such screens because there simply isn't enough value left in the market to generate a decent showing of stocks that satisfy the screening criteria. That's particularly the case with my Safe Yields screen. Even though the key valuation criteria – a yield of 3 per cent or more – is hardly a demanding one, not a single FTSE All-Share stock has has been able to meet this requirement along with the screen's eight quality tests.

While the failure to find any fully-qualifying Safe Yield shares could be viewed as something of a red flag for anyone harbouring concerns about the market being overvalued, from a pragmatic screening perspective the only thing to do is to adapt. The way I have adapted the screen is to allow stocks to fail one of the quality tests, which has resulted in nine positive results. I actually had to resort to a similar tactic when the I first ran the screen in 2011, although, the problem I faced then was more to do with companies lacking strong track records following the credit crunch, rather than a valuation issue.

It's a shame to have to water down the screen given the strong performance it has produced over the past 12 months. The five stocks selected a year ago produced a 22.2 per cent total return compared with 6.5 per cent from the FTSE All-Share. What's more, all of the shares selected by the screen outperformed the market over the period by a good margin (see table).

NameTIDMTotal Return (16 Jul 2013 - 14 Jul 2014)
WH SmithSMWH53.1%
Hilton FoodHFG31.9%
Hill & SmithHILS15.8%
Micro Focus Int.MCRO16.8%
British Sky BroadcastingBSY9.2%
Average-22.2%
FTSE All-Share-6.5%

source: Datastream

Despite the fact that my Safe Yield stocks are selected in part due to their low betas (a measure of low volatility often associated with defensive shares) the screen has outperformed the market over each of the three 12-month periods I have monitored it. The cumulative total return from the strategy, based on switching into the new portfolio selection on the publication date of each article, now stands at 69.1 per cent compared with 30.8 per cent from the All-Share (see graph). It should be noted, though, that these performance numbers do not account for the expenses of buying and selling shares and therefore overstate any 'real world' gains that could have been achieved.

As with other screens that put a strong focus on the underlying quality of a company as an indicator of potential longer-term returns, looking at the portfolios based on a one year holding period is perhaps not the best way to assess the screen's success. Indeed, while the cumulative total return is strong, the return from sticking with a portfolio for the long term is significantly stronger in some cases. The 2011 portfolio, for example, has returned 79.7 per cent compared with a 69.1 per cent cumulative total return over the same period. Both approaches have smashed the 30.8 per cent from the index. Still, it is hard to make clear statements about optimal holding periods based on my very limited sample group. Nevertheless, it is encouraging that all the portfolios have outperformed the market (see bar chart).

As well as looking for a low beta as a pointer to low-risk shares, the screen looks for several other signs that shares are backed by quality businesses. These measures are based both on track record, such as the three-year dividend growth test, as well as some classic measures of operational performance, such as return on equity and cash conversion, and indicators of financial strength. The full criteria are:

■ Dividend yield of at least 3 per cent;

■ Dividend cover of at least two times;

■ Interest cover of at least five times;

■ Dividend growth in each of the past three years;

■ Forecast earnings growth in each of the next two financial years;

■ An average return on equity over the last three years of at least 12.5 per cent;

■ Cash conversion (measured as cash from operations as a percentage of operating profit) of over 100 per cent;

■ A market capitalisation of at least £250m;

■ Beta of 0.75 or less.

The five highest yielding of the nine shares selected by the screen are given a write up below while details of the remaining four can be found in the accompanying table.