Hunting for dividends in the Goldilocks zone

It goes without saying that dividend investors want a reasonable yield, but what is reasonable? 

Some investors are happy with yields of 2% or less because they believe high growth tomorrow will more than compensate for a low yield today. But for investors who want a decent income today, 2% is unlikely to be enough for all but the most wealthy.

At the other end of the scale, some investors will only invest in high yield opportunities, aiming for something close to and preferably above a double-digit yield. At first glance this seems like a no-brainer, but don’t forget that dividends are not guaranteed and promises of double-digit yields are often followed by the reality of dividend cuts and suspensions.

For most dividend investors then, looking for shares where the dividend yield is in the Goldilocks zone (not too high and not too low) is sensible. Of course, what is too high or too low is subjective, but I think something in the range of 4% to 8% is a good starting point.

So in this month’s Master Investor magazine, I decided to focus on a couple of FTSE All-Share companies, both of which have more than ten years of unbroken dividend payments and a starting dividend yield north of 4%.

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A few thoughts on coronavirus and the recent stock market crash

Unless you are a hermit living in a very remote cave, I’m sure you’re aware of the coronavirus pandemic.

And if you have any interest in investing, then you also probably know that stock markets around the globe have suffered what can only be described as a stock market crash.

Crash is a strong word, but with the FTSE 100 falling 26% (from 7,500 to 5,500) in less than a month it’s hard to call it anything else.

Technically speaking we are now in a bear market, which is somewhat arbitrarily defined as a decline of more than 20% from recent highs.

What does this mean for investors? Should we sell now and hide under a rock, or is there some alternative?

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Is Diageo’s share price too high?

Diageo share price chart

Diageo’s share price has increased by more than 300% since the financial crisis of 2009. In this article, I argue that the share price is somewhat stretched and that expected returns are not particularly attractive. I also calculate a target price at which I would be happy to invest.

Diageo is a well-known and generally much-liked business. It develops and manufactures alcoholic drinks such as Smirnoff, Guinness and Johnnie Walker, which it then sells in more than 180 countries.

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Hunting for sustainable dividend growth

I write the regular Dividend Hunter column for Master Investor magazine, and in the February issue I wrote about sustainable dividend growth and how to identify it.

In almost all cases, long-term dividend growth is unsustainable without earnings growth, earnings growth is unsustainable without revenue growth and revenue growth is unsustainable without capital employed growth.

In practice, this means companies can only produce long-term sustainable growth if they employ more capital to fund more factories, warehouses, vehicles, machines, robots, offices, computers and an endless array of other capital assets.

Or to put it another way, if you’re looking for sustainable dividend growth, you should start by looking for sustainable capital employed growth…

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FTSE 250 CAPE valuation and long-term forecast

FTSE 250 Cape chart

Mean reversion of market valuations will be one of the primary headwinds or tailwinds affecting your portfolio over the long term. In this article I look at the FTSE 250’s cyclically adjusted PE ratio (CAPE), and whether it’s likely to help or hinder your portfolio over the coming decade.

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Ted Baker’s collapse is a lesson in the dangers of too much growth

Ted Baker share price collapse

Ted Baker was by far my most disappointing investment in 2019.

As outlined in my recent annual performance review, Ted Baker’s share price fell by about 74% during 2019, contributing -2.7% to the UK Value Investor model portfolio‘s overall 2019 return.

Normally I don’t like to comment on the short-term ups and downs of specific holdings, but Ted Baker recently suspended its dividend and for me that’s more than enough reason to carry out a full mid-term review.

The eagle-eyed among you will know that this review comes only a few months after a similar mid-term review of Xaar. That, of course, is not ideal, but we are where we are and the best path forward is to review the situation, to learn, to evolve and to try to avoid similar situations in future.

And in case you’re interested in the history of this investment, you can read a 2018 review of Ted Baker which I wrote shortly before investing in the company.

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Why Admiral is my favourite dividend growth stock

At this time of year, many investors like to talk about which stock they think will perform best over the coming 12 months.

As a general rule I’m not a huge fan of cheerleading individual companies, especially over the short-term, but this year I thought I’d join in and write about Admiral Group, the UK’s leading car insurer, for the January issue of Master Investor magazine.

Let me be clear: I’m not in love with Admiral, but if I had to pick a favourite investment then Admiral would be it.

There are lots of reasons why, such as the fact that Admiral has produced consistent growth and average total shareholder returns of almost 16% per year since I first invested in 2013.

But that’s all in the past, and in investing it’s the future that counts.

And on that front, I think Admiral is probably more attractively positioned and more attractively valued today than it was when I became a shareholder.

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2019 Value investing portfolio review

2019 value investing portfolio review

Welcome to the annual UK Value Investor portfolio review, in which I either a) bask in the glory of my investing genius or b) role out a long list of excuses as to why I underperformed the market again.

In this review I’ll briefly touch on a range of topics including performance (of course), what went wrong, what went right, what I bought or sold and what returns I expect from the market over the next few years.

But first I want to provide some context, so here’s a quick review of my investment goals and overall strategy.

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Is it too late to invest in UK housebuilders?

As a group, UK housebuilders have produced astonishingly good financial results over the last decade.

This has given their shareholders equally astonishing returns, with average share price gains from the largest housebuilders at close to 1,000% since the 2009 financial crisis.

One housebuilder in particular, Bellway, sits at the very top of my stock screen, thanks to its impressively consistent double digit growth, high profitability, low debts and a dividend yield of around 4% (at a share price of 3,800p).

And following the Conservative’s win in the 2019 general election, Bellway’s share price jumped another 10% or so, rewarding shareholders with yet more capital gains.

So are housebuilders set to produce similarly impressive returns over the next decade, or has this particular house party already run its course?

I’ll try to answer that by first looking at the financial results which underpin those impressive share price gains.

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Marks & Spencer: The destroyer of shareholder value

I like Marks & Spencer. No really, I do.

I used to buy most of my clothes from M&S back in the late 1980s and early 1990s, when I was in my late teens and early 20’s. The clothes were well made, the designs were mainstream and the consistency of quality and sizing was second to none (at least in my local high street). 

But that was a very long time ago and since then M&S has lurched from crisis to crisis, carrying out what seems to be an endless transformation project to “make M&S special again”.

This endless transformation has been incredibly expensive. For example, over the last 20 years M&S has retained about £2.5 billion of shareholders’ earnings to invest in the existing business, to make acquisitions, to buy back shares and so on. And yet, after all that hard work and investment of cold hard (shareholders’) cash, the company’s share price is lower today than it was 20 years ago. 

For most shareholders then, M&S has been a disaster for at least two decades.

So in my latest article for Master Investor magazine, I wanted to outline two red flags which, for many years, have suggested M&S was a no-go zone for long-term investors.

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My worst investment ever

Okay, so this isn’t actually my worst investment ever (I managed to invest in Yellow Pages provider Yell before it went bust in 2013), but it’s pretty close.

The company in question is called Xaar.

It’s a small-cap “disruptive” technology company, and that immediately puts it somewhat outside my usual hunting ground of long-established FTSE 350 dividend payers.

Since I invested in 2018, Xaar has had an existential crisis which resulted in the dividend being suspended and its shares are currently down by about 85% from where I bought them.

This is not good and several years ago I would have sold the company almost as soon as it suspended its dividend.

However, I think that’s an overly simplistic knee-jerk reaction, and that’s something I generally try to avoid.

That’s why, rather than sell immediately, I decided to spend a fair bit of time re-reviewing Xaar from the ground up. I wanted to know: 1) how much of this loss was down to bad luck, 2) how much was down to a bad investment process and 3) how much was down to a bad analyst (i.e. me).

You can read about my Xaar blunder, what I’ve done to fix the root causes and what I intend to do with the shares in a recent article I wrote for Master Investor magazine ( linked below).

In summary though, it’s a bit of all three.

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The Restaurant Group: Weak profitability, long leases and high debts

The slowing UK economy revealed TRG’s underlying weaknesses

The Restaurant Group (which I’ll shorten to TRG) joined the model portfolio in early 2016, shortly after the company published some very upbeat 2015 results.

Revenues were up 8% while earnings and dividends per share were up 13%, continuing the company’s long track record of impressive results.

But then things started to go wrong in its core restaurant business (TRG also runs pubs and airport concessions, and these continued to perform well).

Initially, this was put down to operational issues, such as a lack of focus on value and service. But despite operational improvements over the next couple of years, like-for-like sales continued to fall. 

By mid-2018, management admitted that TRG’s problems were structural rather than cyclical.

Key problems included reduced footfall at restaurants in out-of-town retail parks (thanks to the shift to online shopping), increased competition from other branded restaurants, new food delivery aggregators (e.g. Just Eat) and increasing costs such as the minimum wage, rent and business rates.

Management’s solution was to acquire Wagamama, a high-growth pan-Asian restaurant chain. This would bring economies of scale and allow TRG to convert underperforming sites into Wagamamas. 

However, Wagamama does not solve TRG’s fundamental problems which are, in my opinion, a lack of competitive advantages, a tendency to sign long leases and (thanks to Wagamama) high debts.

For these and other reasons, I have decided to sell TRG this month.

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How to measure your portfolio’s returns (unit valuation system vs internal rate of return)

A few weeks ago a reader asked me about the unit valuation system as he was thinking of using it to measure the performance of his investment portfolio.

I knew what the unit valuation system was, but it wasn’t something I used myself so I said I would write a blog post about it once I’d looked into it.

However, as I researched the unit valuation system it became clear that a different metric, the internal rate of return, was generally preferred as a measure of portfolio performance. So in the rest of this post, I want to describe what these performance metrics are, why the internal rate of return is better and why it might be a good idea to use both.

Free spreadsheet: If you’re familiar with these portfolio performance metrics then take a look at the free resources page. You’ll find a spreadsheet that can calculate returns using both the unit valuation system and the internal rate of return.

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Woodford’s closure, FTSE 100 valuations and The Property Chronicle

Unfortunately for his investors, Neil Woodford’s flagship fund is to be closed in the new year.

(Update: The entire Woodford empire is now closing down)

This is obviously terrible news as a lot of people could lose a lot of money.

I don’t want to trivialise this by jumping on the news-cycle bandwagon, although I guess that’s how this is going to look.

I saw a lot of “lessons from Woodford” articles across my news feed this morning, so I though I would apply the Tesco philosophy of “every little helps”, and re-publish an article I wrote a few weeks ago.

I wrote it for a new magazine called The Property Chronicle, published by those nice people at Harriman House (who also, not entirely uncoincidentally, publish my book).

Reading back through the article, I think two lessons are paramount (one of which I forgot to mention):

  1. Don’t borrow short and lend long (or in this case, don’t invest cash into assets that could take months to sell if you might need the cash back at short notice)
  2. Diversify, diversify, diversify (even if that means holding several funds which are themselves diversified)
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The hidden debt of lease obligations

Unless you’re an accountant or an experienced and well-read investor, chances are you either haven’t heard of capitalising lease obligations or, if you have, it’s something you don’t do because it can be a lot of work.

Until recently I fell into the second group. I knew what lease capitalisation was (don’t worry if you don’t; I shall explain all shortly) but I didn’t do it because a) none of my investments had problems with crippling lease obligations and b) it was a lot of work.

However, the argument (or excuse) that it’s all too much work is about to become null and void, thanks to a new accounting standard known as IFRS 16: Leases.

This new standard is about to shine a great deal of sunlight onto what was previously a dark and largely hidden debt, so now seemed like a good time to review the basics of lease obligations and how much of what is generally a good thing can be too much.

After much pondering, frowning and chin-scratching I came to the (long overdue) conclusion that lease obligations are basically the same as debt obligations.

You can learn a bit about lease obligations and how I’m going to factor them into my investment process in this month’s Master Investor magazine (below).

I’ve also included Burberry, The Restaurant Group, Next (all of which I own) and Marks & Spencer (which I don’t own) as examples of how the hidden debt of lease obligations can seriously distort the accounts of retailers and other property-based businesses.

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Mitie disappointment or Mitie dividend potential?

Mitie Group is the UK’s largest facilities management (FM) company and it joined my personal portfolio and the UK Value Investor model portfolio way back in 2011.

In layman’s terms, Mitie provides corporate and government clients with outsourced services (mostly property-related such as maintenance, security and cleaning) so that its clients can focus on their core activities rather than non-core activities like fixing a boiler or cutting the grass.

When I bought Mitie in 2011, it had a long track record of impressive and steady growth, and that’s largely why I invested (my investment criteria are now much more demanding).

But that was then and this is now, and over the last few years, Mitie and other large diversified outsourcing conglomerates (notably Capita and Carillion) have run into all sorts of problems.

Mitie began its turnaround journey in 2017 with a dividend cut from 12p to 4p, and that’s where the dividend remains today.

That turnaround process is now largely complete, so the next few years will be the litmus test as to whether all the hard work restructuring the business has been worthwhile, and whether the dividend can be increased back to previous levels and beyond.

Personally, I’m mildly optimistic, and I’ve outlined why at some length in this month’s Master Investor magazine.

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Selling SSE: A defensive utility with lots of problems

  • SSE joined the UK Value Investor model portfolio in late 2011 with a track record of steady growth.
  • Under the covers, there was a lack of focus, low returns and high debts which I didn’t fully appreciate at the time.
  • The dividend is soon to be cut, and with the dividend goes any remaining reason to hang onto this problematic company.
SSE results table 2019 09
Dividends provided the bulk of SSE’s mediocre returns

“SSE is engaged in the provision of energy and related services in the United Kingdom and Ireland, and the developing, operating and owning of energy and related infrastructure”

Company website: sse.com
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