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Judge a company by its dividend

Why it’s worth paying close attention to dividend payment patterns
December 13, 2018

After a poor October, November brought some respite. A slight softening of the rhetoric from Federal Reserve chairman Jerome Powell was grasped by markets. Equities rallied strongly in the closing days of the month on hopes that interest rate increases would be more muted than previously anticipated. Optimism that the US and China would come to an accord on trade at the G20 summit in Argentina also buoyed sentiment. Far Eastern markets rallied the most, with Hong Kong, India, Japan and China up 6.1 per cent, 5.1 per cent, 2.0 per cent and 1.9 per cent, respectively. US equities also moved into positive territory, with the S&P 500 up 1.8 per cent and the tech-heavy Nasdaq up 0.3 per cent. European markets, however, struggled, with the Dax down 1.7 per cent and the CAC down 1.8 per cent. Brexit uncertainty aside, the UK fared no worse than other European markets. The FTSE All-Share (total return) Index fell 1.6 per cent. Outside the FTSE 100 the story was rather different, with the FTSE 250 off 2.3 per cent and Aim All-Share, where liquidity seems to have dried up, off 4.7 per cent. The Aim All-Share is perilously close to entering a bear market, nearly 20 per cent off its high achieved only a few months ago.

Brent crude’s dramatic fall from grace continued unabated, with a fall of 20.7 per cent in November and over 30 per cent from its early October high. With cold weather hitting North America, US natural gas was the place to be, with the price up 42 per cent, to its highest in four years. Gold was stable, ending the month up 0.8 per cent at $1,227 (£972) per ounce. As yet, though, there is little evidence of a stampede in to gold as a hedge in these more nervous markets.

 

Performance

A much better month for the JIC Portfolio after November’s poor showing. The Portfolio defied the market to finish up 3.2 per cent, and for the first time this year, ahead of the FTSE All-Share. I know focusing on calendar years is a little arbitrary given investing is a long-term game, but, with a5.6 per cent shortfall to make up to get into positive territory in 2018, there is all to play for. If the first week of December is anything to go by, it is going to be a pretty tough ask. Since inception in January 2012, the JIC Portfolio is up 163.8 per cent, (+15.1 per cent annualised), comparing favourably with the +72.1 per cent, (+8.2 per cent annualised) return of the FTSE All-Share (total return) Index.

Six of my holdings were up more than 10.0 per cent during November, with only one down more than 10.0 per cent. Miton (MGR), the investment manager was off 11.3 per cent, unsurprisingly given its exposure to equity markets and especially its focus on small-cap funds. I think the sell-off in its shares is probably overdone given its growing multi-asset fund offering, but it is nevertheless geared to equity markets. Serica Energy (SQZ) was the biggest success, up 26.0 per cent ahead of the 30 November completion of its purchase of North Sea assets from BP and Total, the so-called BK and BKR deals. This was a truly transformational deal, with daily production up from just under 2,000 barrels of oil equivalent per day in 2017 to over 25,000 per day forecast for 2019. I’m sticking with it as I think the market it still under valuing the cash flow that should be generated over the coming years and management’s ability to use it to further enhance shareholder value. I would be amazed if the BK and BKR deals were the last we saw from this team. Bioventix (BVXP) bounced back 21.2 per cent, pushing on to new highs. Investors are attracted by the undoubted quality of the company and Peter Harrison, its CEO, gave his usual understated and reassuring presentation at the Mello London investor event. Baillie Gifford Shin Nippon (BGS) and India Capital Growth Fund (IGC) were up 12.5 per cent and 11.1 per cent, respectively, benefiting from improved sentiment concerning global growth. In addition, India, a big importer of oil, received a boost from the falling oil price. Anglo Pacific (APF), up 10.9 per cent, was also helped by improved sentiment on global growth, which saw industrial metal prices rallying.

I have had little benefit over the last seven years from takeovers. Apart from Ithaca Energy, acquired early last year, there have been no others until Faroe Petroleum (FPM) received an offer from 29 per cent shareholder, DNO, on 26 November. DNO has offered 152p a share, which seems both cheeky and opportunistic. The share price was over 170p at the end of September and, although the oil price has fallen back, one should not really be valuing an exploration and production company off ‘spot’ oil prices. I expect that the 152p bid was a sighting shot and that to gain control DNO will have to sweeten the deal considerably.

Activity

The handful of trades in November was aimed at boosting the dividend income within the Portfolio. On the first of the month, I sold my Standard Life Smaller Companies (SLS) at 447p, freeing up some much-needed cash. I reinvested much of the proceeds back into Royal Dutch Shell (RSDB), (1 November at 2,486p) where the 6.0 per cent yield was too tempting. On 13 November I added to Strix (KETL) at 136.9p and again on 21 November at 128p. Strix, the leading global maker of kettle controls, which I covered in my July column, strikes me as being one of the most stable businesses in my Portfolio. I think the forecast dividend yield of well over 5.0 per cent for calendar 2018 significantly undervalues the company. With 10 per cent dividend growth forecast for next year, time will tell whether this was a good entry point. After selling half of my Avation (AVAP) in October I decided to sell the remainder to free up cash to add a new position, Duke Royalty (DUKE). Avation has been a successful holding and although I know one should run one’s winners, I was attracted by the higher dividend yield and dividend growth prospects at Duke Royalty. There is more on the company and my reasons for buying on my website www.johnsinvestmentchronicle.com.

 

The importance of dividends

One of the star presenters at Mello London was long term private investor and regular FT Weekend columnist, Lord John Lee. There are many different approaches to investment, but he has always espoused the importance of dividends. He put his ‘belief’ in the importance of dividends down to his accountancy background which instilled in him that you should only spend out of income and not capital, unless you absolutely have to. When looking at company results, the first thing he will ask is what has happened to the dividend. The dividend should reflect three things; the previous year’s results, the board’s confidence in the year ahead, (as no sensible board wants to cut a dividend) and that it has the cash to pay it. He believes that a dividend yield provides a prop to a share price, especially in a ‘bear’ market. Stocks on high PE ratios offering no yield have no such prop. He was rather dismissive of special dividends, as in his experience it rarely results in the company achieving a higher rating. He thinks, rather than paying periodic “specials”, companies should incorporate them in to the growth in the annual dividend. This, he believes, results in a higher valuation. As a rule, he looked for companies that were growing the dividend by 10.0 per cent a year.

I have a lot of sympathy with this approach and had great success with H Clarkson, prompted by John Lee’s FT column nearly 20 years ago. During the 2000-2003 bear market it was paying you to wait, with a dividend yield of around 7.0 per cent, (although it momentarily peaked at 10.0 per cent in September 2002). Over the next three years it more than doubled the dividend and then increased at high-single-digit percentages for many years to come.

Dividend income has been an important contributor to the overall return of the JIC Portfolio. In its first full year, 2012, dividend income was £2,519. In 2013 it was £4,613, in 2014 – £7,027, 2015 – £8,653, 2016 – £11,067, 2017 – £11,097 and in 2018, it looks like it will pay £11,365. Over the seven years of JIC, £55,512, or 24.0 per cent, of the £229,000 increase in value of the Portfolio has come from dividends. On current projections, dividend income from my current holdings should hit £12,500 in 2019. I will keep ploughing that back into the Portfolio. After all, reinvesting dividends and leaving compounding to do its work has been a major component of investment returns over time. £10,000 invested in the FTSE All-Share would have grown to £17,920 during the 10 years ended 30 November 2018 but with dividends reinvested would have more than doubled to £25,670. That is over a comparatively short period; the longer the better with compounding.

Outlook

Given the UK’s underperformance over the last few years, there has been much commentary in recent weeks on the attractive valuation of the UK market. Much of this absolute and relative undervaluation is most probably down to Brexit uncertainty. 

According to Stockopedia, the median PE ratio of all stocks with estimates is 11.4 times, with earnings growth forecast at 11.5 per cent. The median forecast dividend yield is 4.1 per cent. As Chris Dillow pointed out in last week’s edition, “if past relationships hold, the yield points to the All-Share Index rising 30 per cent over the next three years, with only a 6 per cent chance of it falling”. 

At some stage, hopefully soon, the uncertainty will be removed and with that in mind I am considering slowly shifting some of my overseas exposure into UK companies. The last few months have seen many companies come back to tempting valuations. I will search for those with attractive yields and the prospect of Lord Lee’s 10 per cent a year dividend growth. That way, my forecast dividend income in 2019 should, hopefully, exceed my current £12,500 forecast. 

John Rosier’s portfolio (at 10 Dec 2018)

NameEPICMkt.Cap (£m)% of portfolio
BioventixBVXP172.27.6
Baillie Gifford Shin NipponBGS521.36.6
Biotech Growth Trust (The)BIOG387.75.3
Scottish Mortgage Investment TrustSMT7,211.35.1
Faroe PetroleumFPM599.64.6
Bloomsbury PublishingBMY155.24.5
Lloyds BankingLLOY39,387.24.2
Serica EnergySQZ346.84.1
StrixKETL264.54.1
U+IUAI274.14.0
IomartIOM379.23.9
Royal Dutch ShellRDSB89,723.13.7
Robo-Stox Global Robotics and Automation GO UCITS ETFROBG 3.7
Anglo PacificAPF259.53.6
India Capital Growth FundIGC98.03.5
Central Asia MetalsCAML374.03.4
Melrose IndustriesMRO8,579.73.3
SynconaSYNC1,748.93.3
AdEPT TechnologyADT87.23.2
Duke RoyaltyDUKE91.23.2
Diversified Gas & OilDGOC575.23.1
Fidelity Japanese ValuesFJV190.52.7
MitonMGR95.32.6
TapticaTAP207.62.5
SuperdrySDRY634.01.9
Vietnam Enterprise InvestmentsVEIL1,016.71.8
Cash depositCD 0.3
Geiger Counter Ltd (subscription shares)GCS 0.1
Fidelity Asian Values PLC (subscription shares)FASS2.40.1