Firm financial dividends

It is notable how the DividendMax optimiser tool is currently highlighting a number of companies which have not yet been covered by our dividend of the week articles and, at the moment, a good number of companies from the financial services sector are beginning to look attractive. This has prompted us to focus this week on the financial services and general financials sectors, which gives us a starting list of 23 companies which qualify for the Optimiser tool: Ashmore Group, MAN Group, Hargreaves Lansdown, ICAP, 3i Infrastructure, Tullett Prebon, Intermediate Capital Group, Aberdeen Asset Management, International Public Partnerships, Provident Financial , Investec, IG Group Holdings, Henderson Group, S&U, Paragon Group of Companies, Rathbone Brothers, Aberforth Smaller Companies Trust, Jupiter Fund Management, 3i Group, Schroders, London Stock Exchange and International Personal Finance.

In order to reduce this unwieldy list, we are going to screen by selecting the largest companies, setting a minimum market cap of £1bn, and looking for an annualised yield of more than 3 per cent. This reduces the list to a more manageable 10 companies: Ashmore Group (ASHM: 400p), ICAP (IAP:381p), 3i Infrastructure (3IN: 135p), Intermediate Capital Group (ICP: 462p), Aberdeen Asset Management (ADN:437p), Provident Financial (PFG:1,549p), Investec (INVP:430p), IG Group Holdings (IGG:607p), Henderson Group (HGG:219p) and Jupiter Fund Management (JUP:392p).

The general rebuilding of the banks and the consequent rise in the stock markets that has been enabled by the mass printing of money as part of the ultra loose quantitative easing policies in the developed world economies of the US, UK and European Union has rubbed off on all of these firms. Counterparty risk has been reduced, thereby improving the climate in which these companies operate. Yet there are still some attractive valuations on offer, as the table shows.

It is also helpful to consider what the City thinks of those companies under consideration. It is particularly notable how very few City analysts are bearish on companies in the financial services sector at the moment, with only seven sell recommendations out of a total of 122 recommendations issued on the 10 companies in our sights. The table below represents the number of brokers in each of the recommendations categories of buy/hold/sell:

There are five fund management companies in the list of 10, but we will only take one of them through to our shortlist in order to maintain diversity. Ashmore, despite currently having the highest annualised yield at 7.2 per cent, is eliminated because it is going ex-dividend this week for 11.75p - there are two finals and an interim payment in this equation. Beyond that, the choice is made relatively easy by the superior record of Aberdeen Asset Management compared with its peers when it comes to consecutive annual dividend increases. It is the only company to boast a record of than five years of annual dividend increases - in fact, its record stretches back to 2005. Aberdeen even managed to maintain increased dividend payments throughout the fallow years of the financial crisis when very few other fund management companies were able to do so, posting increases, albeit small, in both 2008 and 2009. Ashmore managed to hold its dividend in 2008, Henderson held its payout in 2008 and 2009, Investec was forced to reduce its dividend in 2009 and Jupiter only started paying dividends in 2010. It is building up a nice track record, but is still some way off boasting a record such as that of Aberdeen.

After picking our one fund management candidate, that leaves us with ICAP, 3i infrastructure, Provident Financial, Intermediate Capital Group and IG Group holdings. Provident Financial is eliminated because it went ex-dividend last week so the time lag until the next dividend date is too long. Intermediate Capital almost halved its dividend as recently as 2011 and does not make the cut for that reason. 3i Infrastructure is an excellent dividend paying stock with a good yield and with steady, if unspectacular, dividend increases of between 3.8 per cent and 9.3 per cent over the past five years. But it is a relatively specialist niche operator, illustrated by the fact that only one City analyst has an active recommendation on the company, so we eliminate it at this point. ICAP had a very good dividend track record up until this year when it could only hold its dividend at the previous year's level. But for its excellent management and recovery potential, we are going to take ICAP through to the shortlist along with IG Group which also has a strong management team and is the undisputed leader in its field.

Let's have a look at the dividends paid by the companies on our final shortlist of three over the past six-seven years:

ICAP

Aberdeen Asset Management

2013 interim dividend of 6p paid.

IG Group Holdings

Purely on valuation grounds, IG Group looks expensive compared with both ICAP and Aberdeen Asset Management, with a higher price to earnings ratio and lower yield than both of them, and so it is eliminated at this stage.

Aberdeen Asset Management is having a great time right now, but some are nervous of financial services companies as new regulations come in and the amounts they are charging come under ever increasing scrutiny. Aberdeen's significant exposure to emerging markets is also a concern considering the recent souring of sentiment among investors towards such investments and the concern that emerging markets could be hit hard by the ripple effect of a tapering in quantitative easing in the US, which could begin early in 2014. I would also highlight a further worry that when the analyst community's consensus is so universally consistent with almost all analysts rating it a buy, there is very little room for error. Aberdeen's recent price history shows a high of 492p and the shares currently trade at 448p. We featured Aberdeen in our first ever Dividend of the Week back in July and, while we do expect a large increase in the final dividend, we feel that the shares are high enough for now.

So we are going to go for a company whose dividend credentials have slipped under the radar somewhat. It has a superb track record of increasing dividends, growing its payout by 79 per cent from 2007 to 2012.

Before this year, it had increased its dividend every year since 2001 and is forecast to continue this trend with further increases pencilled in by analysts for 2014 and 2015. The dividend increased by 450 per cent during this time from 4p in 2001 to 22p in 2012. The dividend is forecast to increase by around 7 per cent this year and next, and the dividend cover is reasonable at 1.5 times.

Benefiting from strong free cash flow, the company has plenty of cash on the balance sheet with relatively low borrowing. The company has also delivered £80m of annualised profit and loss cost savings which should benefit margins, and the uncertainty over its part in the Libor fixing scandal now appears to have been resolved after the company was fined £54m for fixing Libor rates - although this issue has not been completely resolved with further fines likely to follow in respect of yen Libor from the US Department of Justice.

At the time of ICAP's recent final results, chief executive Michael Spencer admitted that the weak global economy, low interest rates and uncertainty over regulatory reform has affected the business. But investment in the business, coupled with the cost savings delivered and the slowly improving global economic outlook, should help it bounce back. ICAP also relies somewhat on confidence in the equity markets and the recent buoyancy here means we could have seen the bottom of the business cycle for the company, leaving it well placed to take advantage.

The share price is currently a fair way from last year's high of 431.5p, currently standing at 382p. Notably, the shares were almost double their current level at over 700p five years ago. There is little doubt that ICAP is a major play on financial market recovery and, while I do not expect them to be firing on all cylinders this year, the medium- to long-term picture is, in our view, strong. The price-to-earnings ratio is relatively low and the yield is already high, marking ICAP out as our dividend of the week.