There's a lot of talk in the market about investors' growing fondness for bond-like equities as they search for better-yielding alternatives to overpriced bonds. The stocks selected by my safe-yields screen certainly seem to fit this theme and the performance of the shares selected by the strategy last year has been very strong - a 26.2 per cent total return compared with 5.1 per cent from the market.
But strong returns have been de rigueur for this screen since I first devised it in July 2011. The safe-yield shares have outperformed every year so far and now boast a cumulative total return since the strategy's inception in July 2011 of 118 per cent compared with 38.3 per cent from the index. If I apply a 1 per cent charge to account for dealing costs and spreads, the cumulative return drops to 109 per cent.
2014 performance
| Name | TIDM | Total return (23 Jul 2014 - 14 Jul 2015) |
|---|---|---|
| Micro Focus | MCRO | 74% |
| Moneysupermarket.com | MONY | 63% |
| Galliford Try | GFRD | 44% |
| Hill & Smith | HILS | 43% |
| Close Brothers | CBG | 23% |
| Jupiter Fund Management | JUP | 15% |
| National Grid | NG. | 2.9% |
| BP | BP. | -8.9% |
| Tate & Lyle | TATE | -20% |
| Average | - | 26% |
| FTSE All Share | - | 5.1% |
Cumulative Performance
The cumulative return is based on switching between portfolios each time a new screen is published. However, the safe yields strategy is probably best regarded as a way of selecting shares that can be bought and held for the long term. So it is gratifying that on a buy-and-hold basis the strategy is doing well, too. Indeed, at 120 per cent, the buy-and-hold performance of the first safe yields screen I ran in 2011 is slightly ahead of the returns achieved by switching.
Buy-and-hold returns
As with many of the screens that I run with a focus on fixed valuation levels (in this case a 3 per cent-plus yield) I've found myself having to soften the safe-yield screening criteria as the current bull market has progressed in order to generate an acceptable number of positive results. The adjustment I made to the screen last year was to allow stocks to fail one of the screen's tests as long as it wasn't the test for a 3 per cent yield. It is pleasing that the selection of stocks performed well despite this relaxation of the rules as I've had to resort to the same tactic this year, too. That said, unlike last year, at least one stock passed all the screen's tests (BBA Aviation).
The approach of the screen is to marry a decent yield with a number of fundamental factors that suggest the company is reliably generating earnings and cash flows that are likely to support the payment and growth of dividends. The test pulls in classic factors such as dividend cover, interest cover and cash conversion to assess the backing for the dividend as well as return on equity to help measure the quality of the underlying business. The shares also need to have a low beta, which is a measure of the sensitivity of a share to wider market movement. The general rule of thumb that investors apply to beta is that a reading of below 1 indicates some kind of defensive quality.
The full list of criteria is as follows:
■ 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 past 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. |
Special dividends have been a factor in securing some shares their place in this year's safe-yield selection. My approach to such situations is to give special payments credit when it looks as though such payments could be on an ongoing basis. One stock (BBA) passed all the screen's tests while a further seven passed all but one test. BBA is written up below, along with the four highest-yielding of the stocks that passed all but one of the tests. The remaining stocks are listed in the table that follows.
