Hunting for income is about more than simply looking for the market's highest-yielding stocks, as a key question for any income investor has to be what dividend payments will be in years to come. Even investors with short-term time horizons need to make this a prime concern, as the value of future income streams is likely to be a central consideration for any future buyer of an income share.
My longer-term income stock screen attempts to look five years into the future to highlight stocks with great income potential, even when they are not boasting a very high yield today. The nine stocks selected by the screen last year have done well. The total return from the nine shares was 12.8 per cent compared with 9.6 per cent from the FTSE 350. Dividend growth came in at 8.4 per cent and the average yield from the nine shares, based on prices at the publication date, was 3.9 per cent.
| Name | TIDM | Total return (1 Apr 2014 - 8 Apr 2015) |
|---|---|---|
| Domino's Pizza | DOM | 48.7% |
| Legal & General | LGEN | 44.6% |
| WPP | WPP | 29.3% |
| Croda Int'l | CRDA | 14.7% |
| Cobham | COB | 7.7% |
| ITE | ITE | 3.5% |
| Mitie | MTO | -8.5% |
| Rio Tinto | RIO | -10.5% |
| Amec Foster Wheeler | AMFW | -14.7% |
| FTSE 350 | - | 9.6% |
| Average | - | 12.8% |
Source: Thomson Datastream
The performance of the 2014 screen represents a good start for what is meant to be a long-term, buy-and-hold type strategy. The performance is also an improvement on the two long-term income screens I ran in 2012 and 2013 (see graphs and table). It is possible the 2014 screen benefited from the inclusion of an additional screening test, which involved looking for forecast dividend growth using data from Sharescope.
| Long-term income screen | Total return | FTSE 350 total return | Current DY* | Annualised DPS growth |
|---|---|---|---|---|
| 2012 | 34% | 38% | 4.3% | 2.5% |
| 2013 | 13% | 19% | 3.6% | 2.9% |
| 2014 | 13% | 10% | 3.9% | 8.4% |
*Based on prices at publication date
Source: Thomson Datastream & S&P Capital IQ
While I am happily sticking by the recently introduced forecast-dividend-growth test, the screen at its heart remains backward looking. That's because it uses dividend-growth track records to try to come up with an implied dividend payout schedule for the coming five years. The screen's "implied" dividends should be seen as a nod towards stocks that may deliver impressive dividend growth and not actual forecasts. This is how it works:
| The screen takes an average of last year's dividend growth and the compound annual growth rate over three, five and 10 years. This average gives more significance to more recent growth periods. The average growth rate is then applied to the most recent full-year dividend and payouts are calculated for each of the next five years. The so-called "net present value" of these payments is then figured out using the prevailing five-year government bond rate to calculate the cost to investors of waiting for future dividends. From this NPV, an average implied annual dividend yield over the next five years is calculated. |
The screen is interested in the quarter of FTSE 350 stocks with the highest implied, five-year annual dividend yields. These stocks must then pass the following supplementary tests.
■ Dividend growth forecast in the current financial year and next financial year. ■ No dividend cuts in the past 10 years. ■ Dividend growth of 5 per cent or more in each of the past three years. ■ A compound annual dividend growth rate of 5 per cent or more over both five years and 10 years. ■ Net debt to cash profits of less than two times. ■ Forecast EPS growth in the current financial year and next financial year. ■ Dividend growth last year must be at least half the three-year compound average growth rate - this is to allow for stocks that may be down on their luck but not completely off track. ■ "Implied" dividend next year must be at least 1.5 times covered by forecast EPS. |
Only three stocks passed the screen this year and I've provided write-ups of their investment cases below. Given the paucity of positive results, I have also included a table of the five stocks that failed one of the seven supplementary screening tests.
THREE SHARES FOR LONG-TERM INCOME
