I have constructed a portfolio composed of shares that fit particular criteria. These are not, I should stress, shares that have high yields because they fall into the 'dog' category, but companies that have increased dividends consistently over at least the past five years and that have a projected dividend yield of greater than 5 per cent.
Incidentally Ben Graham noted at the time the fourth edition of his book was published in the early 1970s that the average yield on US stocks over the period since the 1870s had been a whisker over 5 per cent. The criteria we have selected for dividend cover is an historic figure greater than 1.8. This is more conservative than the average observed by Graham, which was a typical payout ratio of 0.66, which translates to a dividend cover of 1.5 times.
We also selected shares that have historical five-year growth in earnings per share (EPS) of at least 5 per cent compound. This implies, with constant cover and on a constant yield basis, that dividends would grow by 5 per cent a year, producing, together with the yield, a total return of 10 per cent a year – doubling the value of the investment over the course of seven years.
Finally, in order to introduce a balance sheet element into the equation, we have also filtered out those shares with gearing greater than 50 per cent. We have also worked on the basis of only taking shares with a market value in excess of £150m, in order to capture reasonably-sized companies. The table shows 10 shares that satisfy the criteria.
Looking a bit more closely at those with the best prospects for dividend growth, according to the current consensus, leaves Clarkson, PayPoint, Interserve, Game, AstraZeneca and Vodafone. A majority of these companies also possess, in addition to the attributes of solid, well-covered, consistently growing yields, a decent return on equity – in several cases 30 per cent or more – and, for the most part, low price-to-sales ratios and low price to cash flow multiples.
Of course, it bears reiteration that no equity dividend is ever completely secure, and that investing in high yielders often involves making an educated guess about the durability of the payment if times get tough. The relative degree of safety in these circumstances is a trade-off between the absolute size of the yield, dividend cover, balance sheet strength, cash flow, and the susceptibility of the company to further adversity.
In this instance, there doesn't seem to be any way of avoiding stock-specific risk through using exchange-traded funds. To judge from data on the FT Actuaries indices, no UK market or sector equity ETFs would satisfy the criteria we have set. The UK mobile telecommunications sector would appear to do so, but its constituents are represented in the list anyway. The UK Select Dividend Plus ETF currently yields around 4 per cent. The FTSE 350 index, for comparison, yields 3.2 per cent on an historic basis with a cover of around 1.98 times.
The investment trust market, however, is a different matter. Recent data from the Association of Investments Companies (AIC) shows that 15 of its member trusts can boast a record of consecutive year-on-year dividend increases greater than 26 years. The highest yielding trusts on the list are Merchants Trust (a yield of 6.74 per cent and a discount to NAV of 8 per cent) and Murray Income (5.2 per cent and a 9 per cent discount respectively and tipped in this issue; see page 42). City of London Investment Trust has the longest number of consecutive yearly dividend increases (43 years) and a yield just shy of 5 per cent.
With a low earnings multiple, a consistently growing dividend, high return on equity, solid balance sheet and low multiple of projected cash flow, Clarkson ticks pretty much all the boxes. The company is involved in ship chartering and ship-broking, which are closely linked to the economic cycle. Shipping charter rates hit a low point in early 2009 but have since begun to recover. Demand for raw materials from India and China should underpin charter rates in the future and Clarkson should be able to benefit from this trend.
Dividends grew from 32p a share in 2005 to 43p a share last year and are expected to edge up in the next two years. Sales and earnings slipped badly in 2009 due to the recession and 2010 figures are predicated on only modest recovery, which may perhaps prove in the end to be a little conservative.
The dividend was twice covered last year on the basis of what should prove to be a low point in the company’s current cycle, and the company has substantial net cash in the balance sheet. The annual cost of the dividend is £8.2m and the company's net cash is currently £38m, after allowing for contracted bonus payments. The share price surged as a result of the boost to shipping rates that followed the grounding of aircraft due to the volcanic ash cloud. This has taken the yield down below the 5 per cent mark so, for the moment, the shares are a buy on weakness to below 900p.
PayPoint is an electronic bill payment collection system, operating through a network of high-street retailers and online to allow individuals to pay bills without using the conventional banking system. The company’s services are used by most leading utilities, telecommunications providers and many consumer service companies.
It has over 22,000 terminals in the UK as well as operations in Ireland and Romania and handles 550m transactions a year, worth in the region of £10bn. It also operates some 2,300 LINK ATM machines and is branching out into 'pay by phone' services through the recent acquisition of Verrus.
Financials look sound and an interim management statement issued in January confirmed that the company was on track to meet market expectation of a single-figure percentage decline in pre-tax profits and earnings per share in the year to March 2010. A rebound is expected in 2010-11.
Dividends more than tripled between 2005 and 2009 and are expected to have grown further in the year just ended, and again in the current 12 months. On an historic basis the payment is twice covered, but this cover will drop to around 1.5 in the 2009-10 period. Return on equity is a healthy 38 per cent and the shares sell on a multiple of around 10 times earnings. It is perhaps a moot point whether the dividend will grow in 2009-10 by quite the amount the consensus suggests. A maintained final dividend, for example, would produce a payment for the year of 19p versus the 22.2p suggested by the consensus. Even on this lower figure, which would be covered 1.7 times by expected earnings, growth would be a respectable 8 per cent and the yield in excess of 6 per cent.
PayPoint's share price has been under the cosh of late, mainly because of fears that Camelot will get approval to provide bill payment services in lottery ticket machines. Operators such as PayPoint have registered their objections with the National Lottery Commission, suggesting that Camelot is abusing its monopoly position. The consultation period is now over, but a decision is not expected until July at the earliest. With PayPoint's established position in this area, and its painstakingly built network of merchants, which Camelot would need to replicate, we believe the market’s concerns over this potential increased competition are both overdone and in any event now fully reflected in the price.
Given that fears on this score look overplayed and that on a conservative estimate the shares now yield over 6 per cent, the shares look attractive.
There is little to choose between AstraZeneca and Vodafone so far as big company exposure to higher yielders is concerned. Vodafone's prospective dividend cover is just over 1.8 times and the yield a whisker short of 5.7 per cent. AstraZeneca yields 5.3 per cent with a slightly more generous cover and both have relatively good dividend growth, with Vodafone's slightly faster.
On the other hand, AZN's earnings growth prospects, to judge from the consensus, look better than Vodafone's, where profits in the year to March 2011 are, despite some recovery, expected to fall short of 2009's figure. In AstraZeneca's case, growth in calendar 2010 takes profits back to the level of 2008, with further modest growth pencilled in for the following year.
Vodafone has made the transition from growth stock to quasi utility, although its recent pronouncements on potential acquisitions in India highlight the fact that there are still dynamic prospects for mobile phones in emerging markets. AstraZeneca has the high margins and return on equity characteristic of pharmaceutical companies. Both companies have similar levels of gearing and similar cash flow multiples.
In the context of this exercise, however, the growth fundamentals are of less importance than the yield-related parameters, which show both companies in the same spot, with the ideal combination of yield and income statement and balance sheet strength, and we rate both shares good value.
Game Group (GMG)
We're including Game here even though for other reasons we are sellers of the company (see '', 21 April 2010). Game is the leading European retailer of PC and video games but it's had a rocky ride of late, losing its long-standing chief executive and another senior manager, and also announcing disappointing results. Game was expected to turn in pre-tax profits of around £89m for the year to January 2010. The figure was actually £84.2m.
However, Game turned in an as-expected dividend, continuing the steady rise in payout seen in the past five years. In the year to January 2005 the payment was 2.2p a share; close on 6p a share is expected for the year to January 2011. So dividend cover is still a solid 2.5 times even if profits fall, as consensus estimates expect, to around £70m in the current year.
Game's shares were harshly treated by the market in the wake of this announcement, and risk is still present. But the solidly covered yield looks tempting even with zero dividend growth this year. Some brokers are starting to come around to the shares. Killik, for example, rates them a hold, observing that: "We believe the appointment of a well-incentivised, external CEO could generate value for shareholders, or a bid from industry peer Gamestop. In the meantime, the well-covered 6.3 per cent yield provides support." For income investors, then, Game could qualify as a speculative buy.
|Market||Historic||Historic||Dividend||Projected||Price change (%) over:|
|Name||TIDM||Price (£)||Cap’n (£m)||Dividend (p)||P/E (times)||Cover||Yield (%)||Month||Year|
|Royal Dutch Shell||RDSB||19.02||51,274||106.3||12.6||1.4||5.82||4||22.6|
Price data as at 4 May 2010