In February 2012 we wrote an article (‘Jam today, jam tomorrow’) which really explored the potential of equities as income generators. We made the observation that in 2011 the dividend payout by UK listed companies increased by 26 per cent to £68 billion. That was a record at the time.
We noted that the financial crisis led to a sell-off in equities, and speculated whether they had become oversold to the extent that they represented attractive risk/reward propositions for income generation. Eight selection criteria were applied:
A historic, and sustainable, dividend yield of at least four per cent. Historic yields of three per cent, which appeared capable of breaching four per cent in the short term, were also considered. We eliminated companies which were overtly expensive, even if they cleared the dividend hurdle.
The company had to be reasonably easy to understand, such that one could independently form an understanding of the opportun-ities and risks. This eliminated complex companies/industries of a technical nature, where specialist knowledge is required.
The industry had to be run by leaders who were sane, rational and risk-conscious. At the time we surmised that this eliminated the banking sector, which appeared to have lost sight of its primary purpose.
We eliminated serial empire builders which appeared more interested in growing the size of the business than growing shareholder value, and translating that into dividends.
We favoured companies which were not exclusively exposed to eurozone domestic demand, which we thought would lag and was subject to substantial systemic risk. We made an exception for utility-type companies.
We applied no geographic filter, except that we eliminated listings in markets where the govern-ance regime is clearly opaque or suspect.
We eliminated shares in companies which are typically illiquid. This eliminated, among others, local shares.
We eliminated any company that looked good on paper, but which for some reason (possibly intangible) we did not feel comfortable about, its management or the space in which it operated. This reflects our belief that there is much more to investing than reducing it to a sanitised exercise in mere mathematics.
We then highlighted a dozen of the qualifying stocks. The table is reproduced, with the addition of performance to date. (Note 1 – Brisa was delisted in August 2012, with an offer price of €2.76).
There is much more to investing than... a sanitised exercise in mathematics
Some developments since 2012 are noteworthy.
From the 2011 record dividend payout of £68bn, 2012 set a new record of £81bn for UK listed companies. 2013 was down slightly at £80bn. However, the 2014 payout is expected to top £100 billion for the first time – with a major push provided by a special dividend of £17 billion from Vodafone following the sale of its $130 billion Verizon stake.
It is also interesting to see how sovereign 10-year bond yields have progressed in the interim (see table).
Note, of course, that as the opportunity cost of holding equities rises, the relative attraction of holding them declines. The divid-end yield would need to grow to compensate, unless a positive outlook would be compensation enough in itself.
This is particularly so for companies that have a large number of investors specifically and primarily attracted by the dividend. There are three major ways in which that can happen.
• Earnings/asset disposals have to grow, while holding the payout ratio;
• The payout ratio has to increase if earnings are flat; and
• Share prices have to decline.
Finally, a look at currency movements (see table).
So much for the past. What opportunities exist today? What is clear is that a number of companies have seen share price rises which exceed their ability to grow dividends commensurately. In other words, the dividend yield has compressed. However, as in 2012, we feel that selective opportunities still exist. In a near future article, we shall run a similar exercise with a view to trying to identify them.
This article is the objective and independent opinion of the author. The information contained in the article is based on public information.
Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.
Martin Webster is the head of equity research at Curmi & Partners Ltd.