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Four shares for long-term income

My long-term income screen has picked out a number of fallen growth stars as potentially promising income plays.
April 20, 2016

The shares of a number of erstwhile growth favourites that have lost their lustre over the past 12 months have been seized upon by my long-term income screen this year. Indeed, there are interesting cases to be made for the income credentials of fallen stars such as Restaurant Group, which now boasts a forecast yield in excess of 5 per cent, and rental group Ashtead, which is expected to start to throw off cash as its investment in growth slows.

My long-term income screen is one of the few screens I run that expressly aims to have a long (five-year) holding period. The screen bases its hopes for future income on an extrapolation of a stock's historic dividend record. The screen has yet to cover itself in glory, as the charts below show, but in my opinion it does come up with some interesting ideas.

  

Long-Term Income 2012

  

Long-Term Income 2013 

 

Long-Term Income 2014

 

Long-Term Income 2015

 

Last year's screen particularly struggled with its search for attractive income, having unearthed more than its share of 'value traps' - Aberdeen Asset Management being the most striking example. What's more, the average performance of the three stocks that passed all the screen's tests (a negative 19.3 per cent total return) a year ago was actually worse than the eight-stock portfolio (-15.1 per cent) which included five stocks that failed to meet one of the screen's criteria. The FTSE 350 delivered a negative 7.5 per cent total return in the period. Still, a lot can change over the course of five years and I'll be continuing to monitor this portfolio.

 

NameTIDMTotal return (14 Apr 2015 - 12 Apr 2016)
RPSRPS-10%
SchrodersSDR-22%
InterserveIRV-25%
BellwayBLWY23%
PayPointPAY-5.1%
Galliford TryGFRD-8.7%
CobhamCOB-32%
Aberdeen Asset ManagementADN-40%
Long-Term Income - Top 3--19%
Long-Term Income--15%
FTSE 350--7.5%

Source: Thompson Datastream

 

The screen itself looks for strong dividend growth potential based on the top quarter of FTSE 350 dividends over the next five years as implied by the historic growth rate. Such a backward-looking forecast can hardly be considered an exacting methodology, but the calculation is made as follows:

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' (NPV) 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 shares that look most attractive on the basis of their implied five-year dividend growth are then tested on several fundamental criteria that suggest the dividend may have solid support:

■ 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 four shares passed all the screen's tests this year. They are given write-ups below and a range of fundamentals relating to the shares can be found in the table that follows.

 

Four shares for long term income