Dividend yields and getting caught on the turn

Sometimes stock screens get caught out by a changing of the guard in economic and market cycles. Being totally frank, investors should think twice about many of the companies that are flying high in our dividend yield screen this month. Royal Mail (RMG) tops the UK large cap screen, with a trailing dividend yield of 7.1 per cent and passing seven out of eight tests. But it fails the forward earnings per share growth test. That’s telling, as the cost of living crisis bites, inflation pushes up costs and industrial strife drags on its competitiveness (never mind operational performance), the high trailing yield is a sign of a good spell in the rear view mirror rather than a signpost for the immediate road ahead. 

Second on the large cap list, 3i Group (III) may be in a tough place cyclically. On the one hand infrastructure investments could be seen as having defensive qualities. But on the other hand, private equity is facing headwinds as the tide of easy money dries up and the economies in which businesses operate are facing much tougher macro conditions.  An investment company, the discount of share price to net asset value (NAV) per share has widened considerably. Share price performance, and therefore discounts,  are often a far better indicator than self-reported NAV of how unlisted assets should be valued in the practical and liquid sense of being able to sell today. Going forward, the environment for asset earnings and disposals is likely to be tougher than it was in the past few years, which could affect the cash made available to pay dividends. 

Some companies have enormous trailing dividend yields because exceptional events have hammered their share prices. That’s the case with Russian-linked precious metals miner Polymetal (POLY) on our large cap screen and in our mid-cap screen, for iron ore pellet business Ferrexpo (FXPO), which has considerable assets and operations in Ukraine.  

Do the screens throw up any good ideas? It’s best to filter out the super high yields during the slowdown phase in this economic cycle. Commodities have done well, but investors need to be mindful of bumps should recessionary conditions bite.