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Three Safe Yield Buys

Another one of my screens has reached the ripe old age of five, boasting a performance record that substantially beats all comparable open-ended investment funds over the period
July 12, 2016

Safe yields seem an increasingly elusive quarry for equity investors. According to recent research by Share Centre and Capita, FTSE 350 dividend payments in 2015 were collectively not fully covered by profits, and for many income stocks the earnings outlook is not encouraging, especially in the wake of the uncertainty caused by Brexit. What's more, income hunters have experienced a number of big dividend disappointments over the past 12 months. This is partly reflected in the 10.5 per cent negative total return from the Safe Yields screen over the last year compared with a negative 2.5 per cent from the FTSE All-Share, which is the first time in the five years I've run the screen that it has underperformed the market.

There is arguably another factor at work in the disappointing 12 months experienced by the screen. Last year I speculated that some of the screen's very strong outperformance in the year to July 2015 may have come down to the fact that reliable dividend-paying equities had become very popular given the fall in bond yields, which had pushed up share prices and valuations. As some perceived safe income stocks have disappointed, a reassessment of such inflated valuations has added to the pain.

That said, while last year's selection of Safe Yield shares has not looked all that impressive during most of the last 12 months, the portfolio was a decent way ahead of the index before the Brexit vote, showing a positive 2.1 per cent total return compared with a negative 2.3 per cent from the All-Share (see table). So, all of the considerable underperformance and then some, has occurred since the referendum result. In fact, the portfolio can be viewed as being somewhat unlucky in having selected a number of stocks particularly exposed to the domestic economy.

 

BREXIT WRECKS IT: 2015 PERFORMANCE

NameTIDMPre-Brexit total return (20 Jul 2015 - 23 Jun 2016)Total return (20 Jul 2015 - 6 Jul 2016)
Bank of GeorgiaBGEO32%24%
NovaeNVA24%10%
BBA AviationBBA4.5%0.1%
Telecom PlusTEP1.0%-5.0%
FidessaFDSA-2.1%-8.5%
Close BrothersCBG-8.3%-33%
Legal & GeneralLGEN-8.3%-35%
NextNXT-26%-36%
Safe Yields-2.1%-10.5%
FTSE All-Share--2.3%-2.5%

Source: Thomson Datastream

 

Last year's underperformance needs to be seen in the round, not least because this screen now has a five-year record. Screens should not be expected to deliver unwavering outperformance, and on a cumulative basis the numbers racked up by the Safe Yield screen continue to look extremely impressive. Based on switching from one portfolio to another each year at the time of publication, the total return stands at 95.2 per cent compared with 35.7 per cent from the FTSE All-Share. Adding in a 1.5 per cent annual charge to account for dealing costs, the total return drops to 81.0 per cent. To put that in perspective, that compares with a total return from the top-performing UK equity income fund out of the 65 monitored by Morningstar over the same period of 71.2 per cent, and a 39.9 per cent median total return (see buy-and-hold performance table).

 

Safe Yield versus FTSE All-Share index

 

I regard the Safe Yield screen as more of a buy-and-hold strategy than some of the other flightier screens I monitor. It is therefore encouraging that on a longer-term view each of the portfolios selected by this screen look good, too, and the original 2011 portfolio is a real belter.

 

BUY-AND-HOLD PERFORMANCE

From JulFTSE All-ShareTotal return
Safe Yields 2011*35.7%149.5%
Safe Yields 201236.1%61.2%
Safe Yields 201310.5%82.8%
Safe Yields 20143.1%24.1%
Safe Yields 2015-2.5%-10.5%
Safe Yields 5-yr cumulative*35.7%95.2%
Safe Yields 5-yr cumulative with 1.5% pa charge*35.7%81.0%
Top 3 IA UK Equity Income Funds
Ardevora UK Income A*35.7%71.2%
Troy Trojan Income O Acc*35.7%69.9%
Royal London UK Equity Income A*35.7%65.1%
Median IA Equity Income Fund*35.7%39.9%

*5-yr total return 20 Jul 2011 - 6 Jul 2016

Source: Thomson Datastream & Morningstar

 

The screen itself looks for FTSE All-Share stocks promising a decent yield of 3 per cent or more and also showing a number of other characteristics that suggest the yield may prove sustainable and could grow. The screen also looks for low-beta stocks, which is a measure of how sensitive shares are to wider market movements. While a low beta is often regarded as a rough-and-ready measure of how defensive a company is, as is evident from this year's screen results, highly volatile shares can still have low betas. The full screening criteria are:

 

■ Dividend yield of at least 3 per cent.

■ Dividend cover of at least two times.

■ Interest cover of at least five times.

■ Dividend growth in each of the past three years.

■ Forecast earnings growth in each of the next two financial years.

■ An average return on equity over the past three years of at least 12.5 per cent.

■ Cash conversion (measured as cash from operations as a percentage of operating profit) of over 100 per cent.

■ A market capitalisation of at least £250m.

■ Beta of 0.75 or less.

 

For a third year, the screen has struggled to find stocks that pass all of its tests. I've therefore once again had to resort to allowing stocks to fail one of the tests - any except the dividend yield test - to generate an acceptable number of results. In fact, the number of results is quite impressive, which can perhaps be seen as a reflection of a general retreat in valuations, especially in Brexit-sensitive sectors.

The one stock that does pass all the screen tests actually only qualifies on the key dividend-yield test thanks to its regular special dividend payments. Given the current economic uncertainty, there is particular reason to feel cautious about the outlook for special dividends even when they have been regular features for several years or represent part of a long-term commitment to return capital. I've therefore included two separate tables of Safe Yield stocks (below) based on those shares that pay special dividends and those passing the tests based only on regular dividend payout. I've also taken a closer look at three of the stocks, all of which currently boast IC buy recommendations.

  

SAFE YIELDS

Special cases

NameTIDMMkt capPriceFwd NTM PEDYDY inc. spec. divPEG3-yr DPS CAGREPS grth FY+1EPS grth FY+23-mth momNet cash/ debt (-)
ITV ITV£6,822m170p103.5%9.4%3.432%3.8%4.2%-27%-£325m
Taylor Wimpey TW.£3,779m116p71.4%9.4%0.939%16%2.0%-33%£223m
Dunelm  DNLM£1,526m756p152.9%7.1%-15%---20%-£29m
Novae  NVA£466m749p93.6%6.6%2.911%8.2%-1.6%-14%£24m
Photo-Me Int'lPHTM£497m132p174.4%5.0%3.525%2.6%7.1%-21%£60m
Savills SVS£743m549p92.2%4.7%3.06.3%1.1%6.8%-27%£151m

 

Regular Joes

NameTIDMMkt capPriceFwd NTM PEDYPEG3-yr DPS CAGREPS grth FY+1EPS grth FY+23-mth momNet cash/ debt (-)
Restaurant GroupRTN£514m257p96.8%-14%-13%1.7%-28%-£32m
Bovis Homes  BVS£843m627p66.4%0.764%13%6.7%-27%£30m
easyJet EZJ£4,028m1,018p75.4%-37%---29%£296m
KcomKCOM£562m109p175.4%-10%-15%-10%1.4%£6m
Headlam  HEAD£357m423p124.9%4.612%0.5%4.9%-16%£44m
PayPoint PAY£591m868p144.9%-12%7.2%6.1%14%£81m
Dairy Crest  DCG£779m554p144.0%2.32%12%4.5%-7.8%-£247m
Moneysupermarket.comMONY£1,280m234p153.9%2.917%5.0%8.4%-27%£17m
Big Yellow  BYG£1,033m663p193.8%0.831%10%12%-12%-£315m
BT  BT.A£38,202m388p133.6%-14%-7.8%8.4%-10%-£10.9bn
Polypipe  PLP£441m222p93.5%0.8-22%9.4%-29%-£196m
Marshalls MSLH£408m207p123.4%0.710%24%13%-38%-£14m
Cineworld  CINE£1,376m518p163.4%2.918%2.4%9.3%0.1%-£245m
Smurfit Kappa  SKG£4,513m1,662p-3.2%-34%4.8%3.2%-7.7%-€3.0bn
Lookers LOOK£385m97p63.2%1.39.9%6.9%4.5%-36%-£451m
Computacenter CCC£855m708p133.0%3.03.1%0.1%5.7%-14%£121m

Source: S&P Capital IQ