Prefer solid performers to show-offs
Investors can sidestep risk by pursuing income from stable companies, such as Vodafone and GlaxoSmithKline, that generate reliable payouts rather than one-off, show-stopping dividends.
Dividends are set to rise in Britain after two difficult years. Once factors such as political uncertainty in the Middle East and North Africa region and the natural disaster in Japan are taken into consideration, risk-averse investors will turn to Britain when seeking income in 2011.
Although Britain cut dividend payments at a faster rate than the rest of the world in 2009/2010, the next year looks more encouraging, according to the latest quarterly Capita Registrars Dividend Monitor.
Britain is a prime hunting ground for dividend-yielding stocks: while 107 British companies cut or cancelled payments over the past year, 342 firms increased or reinstated their dividends. Overall, the Monitor expects British dividends to return 4.4% over the next year, representing a 10.5% rise to £62.4 billion.
However, investors should not go in search of impressive dividends at all costs but should seek out equity income from stable stocks that have a high likelihood of increasing their payout. Some high-yielding stocks may have made impressive payments over the past quarter or year, but this strategy can have its downside, given some companies’ predilection for offering a sizeable dividend as compensation when their share price has tumbled. High dividend yields can also reflect investors’ negative views of a stock’s worth and prospects. (Strategy continues below)
Stable stocks with a track record of consistent earnings growth, which provide regular and reliable income for low-risk portfolio strategies, are generally cash-generative growth companies. These will not only pay promising dividends to investors but also offer a high overall absolute return once long-term capital appreciation is taken into consideration.
The key is to find high-yielding stocks with low betas relative to the market, which are and will continue to be attractive to risk-averse investors, such as those in retirement whose savings and derived income have been affected by the low Bank of England base rate. One method of finding such companies is to focus on those that have increased their annual cash dividends for five or more consecutive years. These include names such as Vodafone and GlaxoSmithKline. But investors should look beyond one or two household names to create a diversified portfolio.
Quantitative methodology reveals that the best-performing of the top 100 British stocks that increased their dividends for five or more consecutive years is Game. This firm, a PC and video games retailer, paid out 8.3% over the 12 months to January 31, 2011. Other top performers include National Grid at 7.2% and Chesnara, a life assurance group, at 6.6%. Close behind are Interserve, a support services and construction company, at 6.4%, and RSA Insurance at 6.2%.
However, each of these 100 stocks provided investors with dramatically higher returns once capital appreciation is taken into consideration. The highest absolute returns came from Arm Holdings, a Cambridge-based technology company, at 136.11%, followed by Diploma, a supplier of specialised technical products and services to the life sciences sector, at 84.1%. Other top performers included: Domino Printing, a supplier of industrial ink-jet and laser printing equipment, at 80.57%; Croda International, a chemical company, at 80.46%; and ITE, an organiser of international trade exhibitions and conferences, at 79.94%.
In terms of absolute returns, these 100 stocks would have cumulatively returned just over 20% to investors in the 12 months to January 31, 2011, if they were weighted using a free float adjusted market capitalisation, according to back-tested data.
Almost three-tenths (28%) of these 100 companies fall within the services industry, followed by the financial services industry at almost 14%, and then by capital goods and consumer non-cyclical stocks. Consistent, top-yielding stocks in America broadly fell within the same industries. It is important to note that the stocks mentioned above have not been selected on the basis of their industry or sector: this is a bottom-up methodology based on the consistency of their dividend payments, which should be the basis of any stock selection strategy focused on stable, high dividend-yielding stocks. Any paradigms to emerge from their selection may shed interesting momentary insights into a particular industry, useful in supplementary analysis, but the true predictor of future performance is detailed analysis of a company’s dividend payments.
This research would be difficult for individual investors to carry out as it involves analysing the annual and quarterly reports of companies over a period of five years or more. But such a level of expertise is available via fund managers and index-tracking products.
Investors should remember the real underlying value of dividends - a reliable source of stable income - as they open their eyes to the true significance of what they can achieve.