The question has practical application. Factor in the special dividend that has been paid to shareholders of IT specialist Fidessa (FDSA) for - yes - the past six years and its shares become a candidate for a high-yield fund such as the Bearbull Income Portfolio. And they would make an interesting inclusion in an income fund since the company, which supplies tailor-made software to players in the financial markets, comes with interesting opportunities as well as having to cope with the long-term contraction in market trading since 2008's credit crunch. Yet without the special payment, Fidessa's dividend yield - at 1.8 per cent - shrinks to barely more than nominal.
Indeed, the question's application has become especially practical since - as I said last week - I have sold the income fund's holding in bookmaker Ladbrokes (LAD). In addition, I have axed the fund's holding in copper miner Antofagasta (ANTO).
That should bring little surprise (see Bearbull, 17 April 2015) because, like Ladbrokes, Antofagasta had cut its dividend. True, it's a pity to axe Antofagasta because its low-cost set up makes it a world leader in its industry and having shares in such companies generally brings long-term benefits to a portfolio. I have sold at 566p, and it may be that I am exiting at the bottom of the market - Antofagasta's share price has dropped almost 30 per cent from its 2015 high as investors get jittery about China's slowing economic growth. But on 2015's likely payout, the dividend yield won't even scrape to 2.5 per cent. That's far too low for a component of an income fund. I can't ignore it any longer.
Still, it may be too much of a gamble to recycle the freed-up funds into Fidessa. Including the special payout, Fidessa's dividend costs approaching £32m, slightly more than the free cash flow that the company has averaged in the past two years; although there is also almost £62m of net cash to help lubricate the payment. First, however, I have to behave like a proper investor and do some analysis to see whether the shares are good value regardless of what the dividend payment may be. After all, dividends only pass on what belongs to shareholders anyway and - however useful they are to an income fund - they have no effect on a company's value, as any amount of finance theory will confirm.
| High-yield possibilities | ||||
|---|---|---|---|---|
| Company | Share price (£) | Market cap (£m) | Dividend yield (%) | Payout ratio (%) |
| HSBC (LSE: HSBA) | 5.88 | 114,410 | 5.5 | 55 |
| National Grid (LSE: NG.) | 8.61 | 32,279 | 5.0 | 63 |
| The Berkeley Group (LSE: BKG) | 34.84 | 4,753 | 5.2 | 58 |
| Bovis Homes (LSE: BVS) | 11.78 | 1,583 | 3.9 | 27 |
| Vesuvius (LSE: VSVS) | 3.97 | 1,074 | 4.1 | 47 |
| Fidessa (LSE: FDSA) | 19.80 | 753 | 4.2 | 50 |
| Primary Health Properties (LSE: PHP) | 4.11 | 458 | 4.9 | 56 |
| Manx Telecom (AIM: MANX) | 1.97 | 223 | 6.7 | 65 |
| Charles Taylor (LSE: CTR) | 2.42 | 159 | 4.4 | 51 |
| Flowtech Fluidpower (AIM: FLO) | 1.46 | 62 | 3.4 | - |
Meanwhile, the table highlights other opportunities. I dealt with Vesuvius (VSVS) last month (Bearbull, 24 July 2015) and a holding in the supplier of consumables for running foundries is a real possibility. But I must decide quickly because, as I write, the shares go ex-dividend in a couple of days.
Of the others, insurance industry services provider Charles Taylor (CTR) tends to deliver less than it should. Even so, flush with new equity, it is a candidate. As are dull-but-worthy Manx Telecom (MANX), which has conventional high-yield merits, and IC favourite Primary Health Properties (PHP), which always looks like a good property play.
Maybe most intriguing is Flowtech Fluidpower (FLO), largely because it is small, fast growing and its shares are on a roll - up about 25 per cent over the summer. True, its shares are only border-line high yield (see table), but the assumption is that the dividend will rise smartly. We may know more about that when the company announces first-half results on 8 September.
The bigger question is whether there is a high-quality business within Flowtech, which is a distributor of all things to do with 'fluid power' - hoses, hydraulic couplings, valves and so on. Alternatively, the concern is that the company's model is closer to that of fast-growing distributors that flattered to deceive. I'm thinking of Aero Inventory and Finelist (remember them?). Cash-rich distributors boosted by the buying power of quoted shares can expand rapidly, especially with the help of acquisitions - Flowtech has made three in the past 15 months. The tougher task is to be properly profitable while expansion sucks cash out of the business, which means making a satisfactory underlying return on capital, then graduating to free-cash profits when growth slows. It's a big ask and many distributors fail it. It's too early in Flowtech's life cycle to be confident about any assessment that we might make, although the situation is interesting enough to merit an attempt.
