Many of my screens over the past year have missed out on the recovery in the resources sector due to their focus on earnings and earnings progression. This has caused them to shun the sector due to plummeting profits on the back of falling commodity prices. However, while reported and forecast profits were definitely reflecting the pain of resources companies this time last year, historic dividends - the key valuation metric used by the O'Shaughnessy Cornerstone Value screen - still looked fine. Indeed, many resources companies this time last year were only just accepting that dividends could not remain at historic levels, which seemed staggeringly late in the day. While that did mean historic dividend yields served as a bum steer for income hunters, the fact that companies were so resistant to tarnishing their dividend record meant high yields ended up proving a strong contrarian guide to value, as dividend capitulation coincided with the market's trough.
This meant last year's selection of 25 O'Shaughnessy Value shares contained a number of resources companies including the likes of BHP Billiton (BLT) and Rio Tinto (RIO), along with companies serving the sector such as Weir. When writing up the screen results last year I felt it necessary to point out that these payouts were unlikely to prove genuine, but that they could prove a contrarian indicator, which turned out to be the case. Indeed, these stocks contributed significantly to the screen delivering a knockout 37.3 per cent total return over the past 12 months, compared with the index's 25.4 per cent - a return which itself was turbocharged by the resources recovery and a long way above the median return from index constituents during the period.
| Name | TIDM | Total return (23 Feb 2016 - 21 Feb 2017) |
|---|---|---|
| Weir | WEIR | 132% |
| Rio Tinto | RIO | 94% |
| BHP Billiton | BLT | 93% |
| BBA Aviation | BBA | 84% |
| 3i | III | 75% |
| Vesuvius | VSVS | 58% |
| TP ICAP | TCAP | 57% |
| Elan* | DRX | 46% |
| Nex Group | NXG | 41% |
| Elementis | ELM | 40% |
| Wm Morrison | MORW | 38% |
| Tate & Lyle | TATE | 34% |
| Old Mutual | OML | 32% |
| Amec Foster Wheeler | AMFW | 32% |
| Beazley | BEZ | 25% |
| Petrofac | PFC | 24% |
| GlaxoSmithKline | GSK | 24% |
| Aberdeen Asset Management | ADN | 22% |
| SSE | SSE | 18% |
| Hiscox | HSX | 9% |
| Persimmon | PSN | 5% |
| Imperial Brands | IMB | 5% |
| Carillion | CLLN | -13% |
| Pearson | PSON | -14% |
| Dunelm | DNLM | -32% |
| FTSE 350 | - | 25% |
| O'Shaughnessy Value | - | 37% |
Source: Thomson Datastream
While the performance of the screen has been very strong, one could perhaps level the criticism at the O'Shaughnessy screen that the gains have been too strong. Its objective is to only modestly outperform the market after all. The screen is also a less aggressive strategy offered to investors by Mr O'Shaughnessy as it is meant to take on similar risks to the market. As the graph of its long-term performance shows, the screen has done a pretty good job keeping in tune with the moves of the FTSE 350. And while the screen marginally underperformed the market the first year I ran it, it has beaten the index in each of the following five one-year periods (see table). It’s also managed to produce a 105 per cent total return over the past six years compared with 55 per cent from the FTSE 350. If annual costs of 1 are factored in, the total return from the screen drops to 93 per cent.
| 12 months from Feb | FTSE 350 | O'Shaughnessy Value | 12-month out/underperformance |
|---|---|---|---|
| 2011 | -2.9% | -5.0% | -2.2% |
| 2012 | 18% | 20% | 1.7% |
| 2013 | 12% | 20% | 6.7% |
| 2014 | 5.9% | 12% | 5.6% |
| 2015 | -9.2% | -2.0% | 7.9% |
| 2016 | 25% | 37% | 9.5% |
Source: Thomson Datastream
The screen is one of the original market-beating systems set out in Jim O'Shaughnessy's 1997 quant tour de force, What Works on Wall Street. The stockpicking approach is straightforward and accessible and is designed to come up with a portfolio of shares to be bought without further research. My screen differs slightly from Mr O'Shaughnessy's original as it's been Anglicised to take account of the fact that London -isted companies are on average smaller than those listed in New York (see criteria below). It's also more risky than the original as the portfolio is made up of 25 shares rather than the recommended 50.
The current obsession with 'big data' feels very in tune to Mr O'Shaughnessy's approach outlined in What Works on Wall Street, despite the book being two decades old. The strategies Mr O'Shaughnessy highlights in his book are based on extensive testing of data to simply see what works. This differs from most other 'guru' screens, which tend to start out with an idea of what makes a successful investment strategy and then build a screen to mimic it. Mr O'Shaughnessy found high yields could produce market outperformance when they came from what he described as 'market-leading' shares. His definition of a market-leading share is:
■ A market value of over $1bn. I've set the market value minimum at £500m. ■ More shares outstanding than the average. ■ Higher than average cash flow per share. ■ Turnover of 1.5 times the average or more. |
I've screened all shares in the FTSE All-Share and Aim 100 and the 25 cornerstone value shares are listed below. The stocks are ordered from highest to lowest yield. Some of the stocks qualify due to their payment of special dividends. Where these are a reasonably regular feature, the stock has been included in the table noted with an asterisk. I've taken a closer look at the three companies showing the strongest three-month momentum below.
O’SHAUGHNESSY VALUE SHARES
| Name | TIDM | Market cap | Price | Fwd NTM PE | DY | Div cover | Fwd EPS gth FY+1 | Fwd EPS gth FY+2 | 3-month Mom | Net Cash/ Debt (-) |
|---|---|---|---|---|---|---|---|---|---|---|
| ITV* | ITV | £8.1bn | 203p | 12 | 8.1% | 1.2 | 0.3% | -0.9% | 22% | -£793m |
| Aberdeen Asset Mgmt | ADN | £3.4bn | 268p | 13 | 7.3% | 0.7 | -0.8% | 5.2% | -6.6% | £750m |
| Centamin | CEY | £2.0bn | 176p | 15 | 7.1% | 4.7 | -19% | -10% | 34% | $428m |
| Phoenix | PHNX | £3.0bn | 774p | 11 | 6.9% | 1.3 | -28% | -33% | 4.8% | £4bn |
| Direct Line Insurance* | DLG | £4.9bn | 359p | 12 | 6.7% | 2.1 | 14% | -5.1% | -0.3% | £439m |
| Admiral* | ADM | £5.0bn | 1,874p | 17 | 6.7% | 1.0 | 3.1% | 3.0% | -4.2% | £70m |
| Inmarsat | ISAT | £2.9bn | 633p | 16 | 6.5% | 1.1 | 20% | -13% | -14% | -$1.8bn |
| Amec Foster Wheeler | AMFW | £1.8bn | 451p | 9 | 6.4% | - | -26% | -11% | 3.2% | -£1.1bn |
| HSBC | HSBA | £131bn | 666p | 14 | 6.1% | 0.3 | 13% | 5.5% | 5.8% | $325bn |
| IG Group | IGG | £1.9bn | 517p | 12 | 6.1% | 1.5 | 2.1% | -6.3% | -39% | £152m |
| Petrofac | PFC | £3.0bn | 875p | 10 | 6.0% | - | 21% | -3.4% | 12% | -$1.7bn |
| Mitie | MTO | £711m | 201p | 13 | 6.0% | - | -46% | 25% | -0.2% | -£263m |
| Barratt Developments* | BDEV | £5.2bn | 515p | 9 | 6.0% | 2.7 | 0.8% | 1.8% | 7.8% | £181m |
| Capita | CPI | £3.6bn | 534p | 9 | 5.9% | 0.4 | -12% | -6.8% | -5.7% | -£2.1bn |
| SSE | SSE | £15bn | 1,542p | 13 | 5.8% | 1.0 | -1.4% | 4.1% | 5.1% | -£7.2bn |
| Marks and Spencer | MKS | £5.2bn | 324p | 11 | 5.8% | 0.8 | -16% | -2.4% | -3.1% | -£2.1bn |
| Royal Mail | RMG | £4.1bn | 410p | 10 | 5.5% | 1.0 | -1.6% | -6.9% | -8.8% | -£472m |
| Persimmon* | PSN | £6.2bn | 2,023p | 10 | 5.4% | - | 15% | 2.8% | 15% | £462m |
| Stagecoach | SGC | £1.2bn | 213p | 9 | 5.4% | 1.5 | -11% | -10% | 3.7% | -£489m |
| Crest Nicholson | CRST | £1.3bn | 528p | 8 | 5.2% | 2.8 | 11% | 8.2% | 17% | £77m |
| Centrica | CNA | £13bn | 235p | 14 | 5.1% | - | -5.2% | 3.1% | 15% | -£4.7bn |
| AstraZeneca | AZN | £58bn | 4,562p | 15 | 4.9% | 1.0 | -15% | 8.5% | 7.3% | -$11bn |
| GlaxoSmithKline | GSK | £80bn | 1,646p | 15 | 4.9% | 0.2 | 8.8% | 0.4% | 10% | -£14bn |
| Greene King | GNK | £2.1bn | 665p | 9 | 4.8% | 2.0 | 1.8% | 2.1% | -10% | -£2.6bn |
| British Land | BLND | £6.3bn | 609p | 17 | 4.8% | 1.2 | 8.0% | -2.0% | 1.6% | -£3.6bn |
*Special dividend payer
Source: S&P CapitalIQ
Egyptian gold miner Centamin (CEY) makes the table of high-yielding stocks as a result of management's decision to deliver a fivefold increase in the payout in 2016, which was an unexpected gift for income-hungry shareholders. The dividend hike followed a knockout year for the group. The company boosted gold production by over a quarter, while at the same time costs plummeted, in part due to falling fuel prices.
The bad news for would-be investors is that this is not expected to be repeated. Indeed, production is expected to drop back a little this year while costs should rise as some of last year's tailwinds go into reverse. This is also expected to be reflected in a fall in the dividend, which broker Numis expects will be slimmed down from last year's bumper 15.5ȼ to 8ȼ followed by 5ȼ in 2018. The forecast for the current year is based on a 50 per cent free cash flow payout compared with 70 per cent last year. And while the official policy is to pay out up to 30 per cent of free cash flow, the fact that the company is sat on a good deal of cash means Numis thinks its forecast could actually be topped.
The company itself boasts a long mine life and has some exciting exploration prospects, which means there is the chance it could prove an attractive acquisition target in a sector where the chances of deals looks good. Much will depend on how the price of the yellow metal performs during the coming 12 months, though (last IC View: Buy, 177p, 16 February 2017).
ITV (ITV) is due to report full-year results between the time of writing and publication of this magazine. When its numbers come out all eyes will be on whether it will pay a special dividend, which has been a regular feature over recent years and is the reason it makes it into the table as a top payer. While the cash will probably be available, despite a £367m pension deficit sitting on top of the net debt reported in the table, there are reasons why the broadcaster may want to hold off.
This year will not see the benefit of a major sporting tournament, which will reduce advertising spending. Uncertainty about the outlook for the economy as the Brexit process rolls on could also weigh on ad spending and make ITV's management cautious. Meanwhile, the group faces the long-term challenge to the traditional broadcasting model from internet streaming, although the company is actively attempting to embrace a digital future and has also been investing heavily in programme making for several years.
All in all, analysts are expecting 2017 to be a flat year for profits, helped by £25m of cost savings. These targets could be increased when the full-year results are announced. For income-hungry investors, even if results disappoint on the special dividend front, the anticipated pick-up in 2018 trading from the World Cup means a resumption of such payments is likely in the not too distant future (last IC View: Buy, 170p, 8 December 2016).
Housebuilders are big dividend payers at the moment thanks to the buoyant conditions in their industry and the reticence of such companies to overinvest into the cycle. Three companies from the sector make it into the O'Shaughnessy Cornerstone Value picks this year.
While Crest Nicholson (CRST) is returning capital, it is also growing. The company plans to take turnover from £1bn to £1.4bn by 2019, which broker Panmure Gordon reckons should boost profits before tax by about 50 per cent. The growth prospects are backed by a strong short-term land bank covering 5.5 years and a number of developments are ramping up output. The company is also involved in build-to-rent, which is attracting a lot of interest from institutional investors.
While housebuilders are not cheap by historic standards based on price-to-tangible-book-value (a classic valuation measure used by investors in the sector), Crest does stand out as looking good value compared with peers considering the returns it is achieving from its business. The attractions of the dividend are reinforced by the group's balance sheet strength, its net cash position and strong cover (last IC View: Buy, 486p, 24 January 2017).
