Granted, really big drops tend to come in clusters. In that fateful year of 2008 the All-Share fell more than 7.5 per cent in three months. Even so, if the market was behaving according to its average of the past 30 years then there should have been four such 7.5 per cent-plus falls since 2008. That we have got away with none prompts the thought – however irrational – that there is a mighty judgement coming.
More prosaically, the UK equity market’s consistent strength – even if it looks feeble set in an international context – provides demanding terrain in which to hunt for high-yield candidates, as Bearbull must do. Certainly few of the stocks I encounter that fit into the high-yield bracket – a dividend yield of, say, 4 per cent or more – prompt the intuitive thought that their share price could double in the coming five years.
Yet this was – still is, really – a rule of thumb I instinctively applied. It’s not even that high a hurdle. Imagine – and I stress we’re talking intuition backed by lots of experience – you see a company that looks as if it can grow its earnings by 10 per cent a year for the coming five years. That’s a decent lick, but hardly mind-blowing. If the market responds to that prospect by shifting up the share rating by even a quarter – say, from 10 times earnings to 12.5 times – then you will have a doubled share price after five years as one virtue – decent growth – prompts another – a higher rating – to kick in.
However, in the high-yield segment of the London market the opposite seems to be happening. Let’s quantify that. For the 159 stocks in the All-Share whose yield, based on the most recent 12-month payouts, is at least 4 per cent, the average price change in the past three years is minus 3 per cent. That compares with a 13 per cent gain for the index. And contrast that with those 140 stocks whose yield is between 1 per cent and 3 per cent, the ones likely to slot into a ‘growth’ category – these are showing an average gain of 45 per cent. So it’s pretty clear where the gains have been accruing.
Still, like it or not – and I don’t much – this is the backdrop against which I must find an additional holding for the Bearbull Income Portfolio. Take tiles retailer Topps Tiles (TPT), which emerges from this week’s search as a feasible candidate. Its shares certainly have the essentials. At 63p, they are priced 56 per cent lower than three years ago and offer a 5.4 per cent dividend yield on a payout likely to be covered almost twice by earnings for the year just ended; understandably, one can imagine that’s the basis for good value.
Very nearly, and definitely so if Topps generated just a little more free cash. Yet capital spending has consistently sucked cash out of the group – at £50m in aggregate in the past five years it is almost twice the amount of depreciation charged. Simultaneously, more often than not the group’s need to grow has demanded more working capital. Of course in a growing business these are not usually faults and Topps’ return on capital – in so far as one can estimate it from the balance sheet – looks high enough to indicate that capital spending in excess of depreciation has created – and will create – extra value.
Thus the Bearbull valuation models come up with figures well above the Topps share price, albeit not in quite the way I would want – a bit too much from future growth (always risky); not quite enough from annuitising averaged profits from the recent past (much more reliable). Meanwhile, the group’s accounts consistently yield a high Z-Score, which correlates well with good share-price performance; the productivity of employees is stable, cash conversion is acceptable and Topps has been able to grow its operations exclusively using internally-generated funds – in the five years to the start of 2017-18 net debt almost halved and no new money was raised via equity.
The trouble, you might say, is that Topps is a retailer, a sector being squeezed dry. Maybe. If there is a sweet(ish) spot in retailing, I would guess that selling tiles – for bathrooms, kitchens, hallways, wherever – comes close. That’s because they are tactile things. You have to see and handle a tile before you buy £1,000-worth for the new kitchen. True, you can make your eventual purchase online, but only after checking out the things in a shop and, because so many lines are retailer-exclusive and manufacturers’ brands are correspondingly weak, you won’t dare buy anywhere but the high-street retailer’s website.
So there should be some resilience in Topps’ business model even if its sales growth will correlate closely with consumer confidence and house prices. That means I can imagine its shares doing a job in an income portfolio even if I struggle to see them doing that doubling trick. Uninspiring? Yes, but that’s the nature of the times.
