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Rethinking UK income shares

Focus on large caps for core income holdings, but choose carefully.
March 3, 2022
  • New Alpha dividend yield screens split out large caps
  • Distinguish between income and deep value plays

Our new UK large-cap income shares screen is topped by Royal Mail (RMG), which has seen its share price fall by almost a quarter in the past three months. Touted as something of a recovery story towards the end of last year, some of the froth in that story has undoubtedly been blown away. The company is still expected to have grown earnings significantly in its current financial year, but analysts are more muted with their full-year 2023 projections.  Nonetheless, thanks to the recent selling, the median forecast of dividend per share currently implies a next 12-month yield of around 6 per cent.  Growth expectations don’t point to a rising pay-out, but what is on offer is better value than it was. 

Like all companies in the defence industry, BAE Systems (BA.) is very much in the public conscience for reasons that we all wish it wasn’t given the tragedy in Ukraine. Steady, if unspectacular, earnings growth is forecast which underpins consensus for a slightly progressive dividend. BAE is rated on slightly over 14 times forecast next twelve months’ earnings, and the dividend yield of around 3.5 per cent looks reliable, albeit for now it fails our test to be among those companies forecast to raise the dividend quickly. 

Barclays (BARC), and the positivity analysts display towards its dividend prospects,  looks interesting for income investors. Although buying into banks for the dividend is a real balancing act of potential risk factors. On the one hand, there is the mixed blessing of rising interest rates. That’s good in the sense it helps banks make an increased net interest margin on loan business, but not if the economy tips into recession and more loans go bad. On the other hand, we have to assume there will be spill-over into the financial sector from a new global sanctions regime against Russia, one of the world’s biggest energy producers.  

The house-building sector is another that could suffer if the impact of sanctions and rate rises is to tip the UK into recession. Still, there have been some interesting results in recent days and unsurprisingly, several housebuilders are ranking well on our Large and Mid-Cap screens. Robin Hardy’s full Alpha analysis of the income prospects for the sector was written before the recent flurry of results, but is worth revisiting. 

Our small-cap screen, which filters through companies listed on the main market and on Aim, is topped by Cake Box (CBOX), which is almost a perfect warning that screens are the starting point not the end of investment research.  The company’s share price has tanked in recent months after some very adverse comments by a financial blogger. The company acknowledged some inconsistencies between its 2021 annual report and results announcements, but maintained there was no material read-through to doubt its reported financial statements.  

Although there isn’t evidence that the Cake Box situation is at all similar, episodes like the Patisserie Valerie fraud live long in the memory for investors, which explains the sell-off. Should this all blow over, Cake Box shares are very cheap, given analyst forecasts for its operating performance are pretty good. Still, playing the market for deep value is very different to income investing, so for the purpose of our report, this isn’t a stock to buy right now. 

New approach to UK income shares

We’ve had a rethink about our Alpha dividend yield screens. Previously we were screening the FTSE All-Share index for large-cap companies and the FTSE All-Small Companies index and the FTSE Aim All-Share index for small-cap stocks. 

This created a problem, however. The FTSE All-Share is a big index and includes many companies that aren’t large cap. There is actually an overlap in some constituents of the All-Share and All-Small indices. This means the results we were getting from our All-Share screen, although the criteria were designed for larger companies, often showed-up small ones.

With that in mind we have re-jigged our UK equity income screens and made the split between genuine large-cap, mid-cap and small-cap (including Aim) stocks, to focus on each group separately.  We’re now splitting the universe for our screens according to the methodology of the Numis index family.

 

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