Join our community of smart investors

Not yielding to temptation

In spite of some juicy dividends on offer if filters were relaxed, we’re sticking to the rules of the High-Yield System
March 13, 2015

Having tightened the rules of the High-Yield System to reflect concerns about over-concentration in certain sectors when I updated the portfolio in November 2014, I determined not to make any adjustments for February’s review. In the six months since I ran the first screen, the portfolio has made 8.66 per cent total returns which is more than twice as good as either the FTSE 350 or the FTSE All Share (which have returned 3.87 per cent and 3.85 per cent respectively) over the same period.

Conducting a review on 18 February, I found that over the past three months the system did slightly underperform the benchmarks; it made 6.44 per cent, the FTSE 350 made 6.86 per cent and the FTSE All Share 6.79 per cent. However, when one considers the corresponding returns from gilt yields or cash, anything over six per cent in three months is not to be sniffed at.

 

Two changes for February

Back in November, I made the decision to limit the total number of shares in any one sector to three. In order that the portfolio should evolve to be more diversified than it was when first run, I added the stipulation that future adjustments should not bring the number of shares in the same sector above two. Recognising the prevalence of the broad financial sectors in the initial screen (life insurance, banks and financial services) I also decided to set a quota of five companies from this grouping.

As it happens, the February update did not push against any of these rules. Homeserve (HSV), is sold on account of combining negative 12-month price momentum and a dividend yield that at 3.34 per cent is below the portfolio average. The other change, replacing TUI Travel, comes about as a result of the merger with its German parent company. The replacements are Carillion (CLLN), a straight swap for HSV in the support services sector, and construction services company Galliford Try (GFRD). Reassuringly, Investors Chronicle currently has both companies on a Buy rating.

The worst performers in the portfolio, Amec (AMEC), BHP Billiton (BLT) and Anglo American (AAL), are all companies affected by weakness in commodity prices. They remain good dividend payers and retain their places by virtue of yields that are all above the portfolio average. I am relaxed about holding these companies - they are providing a good income and when commodity prices recover, the portfolio will be sure to benefit.

 

New shares 18/02/2015

Share price (p)Market value (£m)12-month price change (%)Dividend yield (%)Dividend Cover ratio (x)Sector Last IC View
Carillion (CLLN: LSE)365.51572.580.164.822Support ServicesBuy 18/12/2014
Galliford Try (GFRD: LSE)14201168.4221.684.231.7Construction servicesBuy 18/02/2015

 

The temptation to tinker

As well as providing discipline against panic-led selling, rules-based systems also prevent investors chasing the latest big story. The rub is that sometimes rules can feel quite restrictive, and at the moment several established companies are paying a higher yield than any of my holdings. As exceptionally high dividend yields can be a precursor of trouble, the High-Yield System filters the top 10 per cent of dividend yields as a quality measure. This excludes companies paying over 5.05 per cent, which along with the system’s requirement for positive 12-month price momentum means the likes of J Sainsbury (SBRY: 6.4 per cent yield), Centrica (CNA: 6.11 per cent) and GlaxoSmithKline (GSK: 5.14 per cent) are ineligible.

Relaxing the dividend yield filter so only the top two per cent would be removed (any company paying over 6.89 per cent) would keep all of these large companies in contention for the portfolio. Changing the positive price momentum rule to three-months would still exclude Centrica (protecting the portfolio from the continued impact milder weather and lower oil prices are having on its share price) but not GlaxoSmithKline and J Sainsbury - giants of the pharmaceutical and food retail sectors, so hardly the riskiest shares on the market.

However, I am not going to continually adjust the rules, so the High-Yield System remains the same and I will continue with the selection methodology that has thus far served me well. A third criteria, that deserves a mention is for companies selected to have a dividend cover (the ratio of earnings per share to dividend per share) of at least one and a half times. When it comes to valuations in general, company earnings are very much the elephant in the room, with PE multiples looking toppy.

With regards to some of the higher dividend payers on the market, it is certainly worth examining the source of payouts to shareholders as some companies simply run down cash piles. Ultimately the High-Yield System is intended as a long-term buy and hold strategy, so it seems prescient to follow an indicator that dividends can be sustainably funded by organic earnings growth when making additions to the portfolio.

 

 

High-Yield System performance 5/11/2014 - 18/2/2015

NameShare price (p)Market value (£m)12-month price change (%)Dividend yield (%)Total returns 05/11/2014 to 18/02/2015 (%)Dividend cover ratio (x)Date addedTotal returns since added (%)
Imperial Tobacco GP (IMT: LSE)305129200.8226.914.211.51.624/07/201420.19
Old Mutual (OML: LSE)217.610676.89183.8813.12.124/07/20149.02
Man Group (EMG: LSE)179.63154.3115.093.135.552.824/07/201447.9
Legal & General (LGEN: LSE)27116103.2913.063.6214.111.624/07/201415.72
TUI Travel (merger - 17/12/14)**437.65328-2.453.157.332.124/07/20147.33
HICL Infrastructure (HICL: LSE)154.81960.812.014.674.511.805/11/20144.51
Anglo American (AAL: LSE)125917584.13-20.674.29-5.32.124/07/2014-19.61
Homeserve (HSV: LSE)*338.11116.72-1.233.34-2.081.724/07/201411.24
Aberdeen Asset Man. (ADN: LSE)462.96164.0417.193.897.511.824/07/20143.3
Close Brothers Group (CBG: LSE)15722348.979.243.126.942.124/07/201424.35
Go-Ahead Group (GOG: LSE)24461051.8716.23.45-2.281.724/07/20149.86
Amec (AMFW: LSE)902.53505.83-18.44.8-9.581.924/07/2014-21.72
LondonMetric Property (LMP: LSE)159998.5913.014.599.083.305/11/20149.08
Segro (SGRO: LSE)413.93072.6316.663.18.154.324/07/201414.92
BHP Billiton (BLT: LSE)1587.533529.11-18.554.39-1.982.124/07/2014-22.27
*Sold. **Sold 17/12/14 due to corporate action