Join our community of smart investors

Hunting reliable dividend stocks

With the changing economic tide the premise of my inflation-beaters screen, which aims to identify reliable dividend growth stocks that should be able to outpace price rises, is coming back into vogue.
February 7, 2017

Could the premise of my inflation-beaters screen finally be about to come back into vogue? The incongruity of this screen's objective with the prevailing economic trends of recent years can be seen as a great example of how quickly consensus thinking can be turned on its head.

Indeed, I devised the screen in 2012 when there was a widespread feeling that quantitative easing (QE) would result in heightened inflation. Not so. In the five years since, precisely the opposite has happened. Punditry quickly moved against the screen's premise, too, and until relatively recently the talk had turned to the prospects of long-term deflation and lower for much-much longer interest rates.

But now it seems views have once again shifted and expectations of an uptick in inflation are once again mainstream. Ironically, this could in theory create some challenges for my inflation-beaters screen which looks to a strong record of long-term dividend growth as an indicator of companies that may be able to keep up with rising prices. The challenge in question is a result of the fact that in the five years since I began running the screen the market has pushed up the valuation of reliable dividend-paying shares as disgruntled bond investors have searched for alternative places to put their money. With bond yields rising, and inflation expectations increasing, these so called 'bond-proxy' shares have come in for a bashing.

Rather than try to second guess the next turn in markets, I think it is better just to run the screen again and see if anything interesting gets spat out. Also, while I originally conceived this screen with a notion of countering the dangers of inflation, at heart it's a screen that uses dividend records as a way to attempt to find reliable, quality stocks. So the screen's success, or more recently lack of it, shouldn't be overly dependent on the inflation theme.

The screen hasn't been doing well in recent years and this has coincided with it getting tougher to find stocks that meet all the screening criteria. In both 2015 and 2016 the results were so few that I've had to bulk up the number of qualifying shares by allowing them to fail one of the seven screen tests.

Over the past 12 months the 21 shares that qualified in 2016 on the relaxed screening criteria delivered a total return of 10.6 per cent, which was roundly trounced by a 25 per cent return from the FTSE 350 - the index on which the screen is conducted. It is worth pointing out that the index performance benefited substantially from a recovery of resources stocks and since these companies had by-and-large tarnished their dividend payment records when I conducted the screen last year, the screen's share picks veered away from this part of the market.

The three shares that passed all the screen tests last year actually did even worse than the relaxed-criteria version of the screen, delivering an average return of 1.2 per cent largely due to the crash-and-burn performance of Restaurant Group (RTN) (see table). In 2015, the three fully qualifying shares underperformed the larger portfolio, too. This could be interpreted as a reflection that in an expensive market, stocks that are attractive on a large range of criteria including valuation (the yield valuation criteria for this screen is actually pretty soft) are more likely to be 'cheap for a reason'.

 

2016 performance

NameTIDMTotal Return (3 Feb 2016 - 2 Feb 2017)
SpectrisSXS67.5%
DiplomaDPLM65.3%
PayPointPAY44.8%
VictrexVCTA35.6%
PrudentialPRU30.9%
WPPWPP28.3%
Close BrothersCBG22.2%
CompassCPG21.8%
SchrodersSDR19.5%
Reckitt BenckiserRB.11.4%
WS AtkinsATK7.0%
WhitbreadWTB3.9%
SageSGE2.0%
GreggsGREG-0.5%
AG BarrBRAG-2.5%
BellwayBLWY-7.0%
WH SmithSMWH-7.7%
StagecoachSGC-15.8%
MitieMTO-23.1%
NextNXT-39.9%
Restaurant GroupRTN-41.4%
Inflation Beaters-10.6%
FTSE 350-25.0%

Source: Thomson Datastream

 

The performance of the portfolios based on weakened criteria makes the long-term performance of the screen still looks decent, with a 68.5 per cent total return over five years compared with 53.3 per cent from the index (see graph). If I factor in a 1 per cent yearly charge to account for dealing costs, the return drops to 60.2 per cent. The long-term performance based on the narrow selection of fully qualifying shares, however, looks poor with a cumulative return of 31.1 per cent, or 24.6 per cent with costs; worse by a substantial margin than the return investors could expect from a stress-free tracker fund. Let's hope things pick up this year.

 

 

The screen itself looks for a modest but useful dividend yield of 2 per cent or more, along with a strong and consistent track record of dividend growth and indications that growth can be sustained based on dividend cover, earnings growth expectations and return on equity. The full criteria are:

■ A rising dividend in each of the past 10 years.

■ 10-year and five-year compound average dividend growth of 5 per cent or more and growth in the past year of 5 per cent or more.

■ Dividend cover of two times or more.

■ Net debt of less than 2.5 times cash profits.

■ A return on equity of 15 per cent or more.

■ A dividend yield of 2 per cent or more.

■ Forecast earnings growth both this year and next.

Only three stocks (Compass, WH Smiths and WS Atkins) passed all of the screen's criteria this year while a further 12 met a weakened criteria. I've provided write-ups of two of these below, along with the highest yielding of the shares passing all but one of the screening tests.

 

NameTIDMMkt capPriceFwd NTM PEDYDiv covFwd EPS grth FY+1Fwd EPS grth FY+23-mth momNet Cash/ Debt (-)Test failed
PayPoint PAY£666m978p154.4%0.45.4%7.5%-9.6%£50mDiv Cov
BellwayBWY£3.1bn2,490p74.3%3.86.1%2.7%3.9%£26m10yr DPS grth
WS Atkins ATK£1.4bn1,454p122.8%2.211.1%3.0%-3.1%-£111mna
WH Smith SMWH£1.8bn1,637p162.7%2.38.0%6.0%10.1%£7mna
A.G. BARRBAG£590m510p172.6%2.4-2.3%2.9%6.3%-£7mFwd EPS grth
Whitbread WTB£7.2bn3,929p162.3%2.42.4%5.7%11.1%-£1.0bn10yr DPS grth
SageSGE£6.6bn613p192.3%1.415.4%8.3%-11.5%-£313mDiv Cov
CompassCPG£23.0bn1,397p202.3%2.017.6%6.6%-2.0%-£3.1bnna
Experian EXPN£14.3bn1,532p202.0%2.13.3%7.9%1.0%-$3.2bn5% DPS grth
Bunzl BNZL£6.8bn2,078p201.9%2.012.2%7.4%-3.4%-£1.2bnDY
Hill & SmithHILS£941m1,200p181.8%2.324.7%6.2%12.8%-£100mDY
Ted Baker TED£1.3bn2,842p241.7%2.313.2%12.6%14.2%-£116mDY
James Fisher and Sons FSJ£759m1,517p191.6%3.39.7%9.7%-5.6%-£106mDY
Halma HLMA£3.5bn914p221.4%2.315.4%7.8%-10.8%-£237mDY
AshteadAHT£8.1bn1,628p151.4%4.122.4%12.4%31.5%-£2.7bnDY

Source: S&P CapitalIQ

 

Catering company Compass (CPG) has established its steady-as-she-goes reputation for growth based on an international trend towards outsourcing catering services. What's more, its business model has relatively low capital requirements, which underpin its strong track record for dividend growth and share buybacks. Indeed, broker Peel Hunt forecasts that the company's commitment to maintain an efficient balance sheet with net debt at 1.5 times cash profits means the group will have £1bn to return to shareholders this year. That's equivalent to 4.3 per cent of the market cap and well above the dividend listed in our table, although buybacks can be expected to make up a good proportion of any capital return.

The group has recently updated the market on first-quarter trading, reporting 2.8 per cent organic growth, which is slow by its standards (organic growth for its last financial year came in at 5 per cent). However, the company has been clear that shareholders should expect a relatively pedestrian first half with a pick-up at the back end of its financial year. Also it's encouraging that action taken to mitigate cost inflation in the first quarter helped underpin a modest margin rise. What's more, growth in the US remains strong, up 7 per cent in the past three months.

There are also some economic tailwinds developing that could benefit the group. The company has suffered due to the decline in commodity prices, which has had a particularly harsh effect on its offshore and remote catering business. Restructuring work in this division has had a positive impact on margin and with commodity prices now in recovery mode there's the chance of improved demand too. Currency movements - especially the strength of the dollar - are also helping the numbers reported by the company. Management has said that if exchange rates remain where they are now they expect operating profits to benefit by £186m, which is about one-tenth of forecasts for 2017.

Last IC View: Buy, 1,432p, 30 Dec 2016

 

Shareholders have few finer examples of a well-managed business decline than WHSmith (SMWH). With sales of the company's traditional fare - stationery, print news and books - in a state of long-term attrition from digital technologies the retailer has been cutting costs and trimming its estate on the high street for several years. At the same time it has been investing in store openings in travel hubs where, unlike the high street, it sees good growth potential and better margins. And the company has also used the strong cash generation from the mature high-street estate to help pep up EPS growth through share buybacks. The strategy has produced excellent returns for shareholders and the shares command a reasonably handsome rating to boot.

A recent update for the first 21 weeks of the company's financial year suggests the strategy continues to serve up the goods. Indeed the update was greeted with a flurry of small broker upgrades. The key positive surprise came from WH Smith's travel business. The division's sales rose 7 per cent in the 21 weeks and were up 5 per cent on a like-for-like basis, helped by rising passenger numbers. Travel generated 47 per cent of turnover last year and 58 per cent of trading profit based on its 17 per cent profit margin, which compared with 9.7 per cent from the high street.

The high-street business has also been performing strongly in the current financial year considering the backdrop of long-term decline for key product categories. Indeed the like-for-like sales decline during the 21 weeks slowed to -3 per cent compared with -4 per cent in the second half of the previous financial year. This was particularly impressive as the fad for adult colouring books which boosted performance last year fizzled out. WHSmith was able to make up for this with increased sales of spoof books and strong seasonal stationary sales. Meanwhile further cost-cutting boosted the gross margin by 90 basis points. The company also continues to add post offices to its estate (32 were added in the period, taking the total to 145) which are viewed as bringing in more footfall to support sales.

The company's good cash generation and encouraging trading is expected to support impressive dividend growth in coming years as well as further buybacks. Broker Cantor Fitzgerald forecasts a 3 per cent yield for the current financial year to the end of August, rising to 3.4 per cent next year and 3.8 per cent come 2019.

Last IC View: Hold, 1,583p, 13 Oct 2016

 

The table does not take account of a forecast special dividend from PayPoint (PAY), which is expected to take this year's payout to almost 9 per cent. Couple that with a recent third-quarter update which reported a 6.7 per cent rise in net sales and one’s left asking: what's the catch?

The answer is that PayPoint faces something of an existential crisis from widespread expectations that digital advances have put the use of cash into a state of long-term decline. Indeed, as less and fewer people use cash for transactions, there is less and less need for the traditional services offered through Paypoint’s terminals (energy meter prepayments, bill payments, benefit payments, mobile phone top-ups, transport tickets, TV licences, cash withdrawals and more). The terminals are a feature in many convenience stores. Investors are currently particularly concerned about energy meter prepayments, which are estimated to account for about quarter of the group’s revenues. This is a market that smart meters could ultimately wipe out and the introduction of a pre-pay price cap could also cause problems. That said the company has developed a service called Multipay which it hopes will entrench it in the market by offering a wide range of payment options beyond its terminals.

PayPoint is also trying to move into new areas where it sees growth opportunities that will allow it to take advantage of its large installed base of terminals in 29,000 shops. Indeed, its Collect+ parcel collection joint venture has shown good growth, although renegotiated deal terms means it faces a drop in its per-parcel revenue which it hopes will be offset by increased volumes. The roll out of a new terminal that provides shop keepers with ways of boosting their businesses’ efficiency, such as stock management, could also boost prospects. And the group’s business in Romania, where cash remains well used, is flourishing. PayPoint also operates 4,000 Western Union Agencies and 4,000 LINK ATMs, which could be hit if speculation proves correct that interchange fees for independent operators are under threat.

The fact that the services provided by Paypoint’s terminals have been so easily leapfrogged in recent years by advances in digital technology and reduced reliance on cash, means investors are likely to stay nervous about prospects. Anxieties are compounded by the fact that the group’s profits are very sensitive to small changes in revenues.

Last IC View: Hold, 956p, 23 Dec 2016