As a dividend-focused investor, I’m always on the lookout for high-yield shares, whether that yield is high relative to the market average or high relative to the company’s peers.
However, as most yield-seeking investors soon discover, high-yield stocks do not always deliver the yield you were hoping for. That’s because dividends can be cut or even completely suspended, and the higher the historic or forecast yield the more likely that is to happen.
This is the dreaded yield trap, where investors are lured in by an attractive yield and then stung with a capital loss when the dividend is cut.
In order to avoid this fate where possible, I’ve built up a series of questions which every potential investment must answer before I’ll invest so much as a penny. These questions are designed to help me avoid companies that are exposed to significant risks, where those risks arise from factors such as large acquisitions, excessive expansion or changing patterns of market demand.
Of course, these questions are not foolproof, but I’ve found them extremely useful in recent years and in the latest issue of Master Investor magazine I’ve covered the first six yield trap questions in some detail.
Over the last few years, Standard Chartered has not turned out to be a good investment, with shareholders being hit by both a rights issue and a suspended dividend.
The root cause was the bank’s balance sheet, which was not able to withstand significant loan impairments caused by a delayed aftershock of the financial crisis.
Having sold my Standard Chartered shares just a few days ago, I think now is a good time to look back at what happened. However, rather than simply crying over spilt milk, I want to focus on why the milk was spilt in the first place and how I (and perhaps you) can try to avoid this sort of unpleasant situation in future.
But before I get into the details, here’s a quick snapshot of the results of this investment.
Halfords has a dividend yield of 5% at its current share price of 342p.
That’s an attractive yield for a somewhat defensive retailer, but in recent years its go-faster stripes (or at least its previously high growth rates) have fallen off.
So is Halfords a future dividend champion or a dividend trap?
I think it’s more likely to be the former, and here’s why.
As dividend-paying stocks go, Mark’s & Spencer is not exactly a “hidden champion”. On the contrary, it’s a company that just about everyone in the UK (investor or not) is aware of.
Because of its long history as the centrepiece of many UK high streets, the company is often seen as a safe and dependable investment, and today the company’s shares can be purchased for about 330p and with a dividend yield of around 5.5%.
Safe, dependable and with a yield of 5.5%; what’s not to like?
But the reality of the last decade or two shows that M&S is not quite as safe and dependable as its enduring presence suggests.
In fact, after recently reviewing M&S I found a company that:
Is strongly cyclical (which is normal for clothing retailers)
Has grown very slowly (and failed to keep up with inflation)
Tends to increase its dividend unsustainably during economic booms (only to cut it back during the next inevitable bust)
Is carrying large debt and pension liabilities (which is usually not a good idea for cyclical companies)
But it isn’t all bad news. If the company continues to focus on its more successful food business rather than its ailing clothing business, then things may just work out better in the future than they have in the recent past.
Today the FTSE 250 stands about 50% above its pre-financial crisis highs and more than 200% above its post-crisis lows.
Those are impressive gains, but has it left the mid-cap market overvalued? I think it has, and the implications for expected future returns are not good.
In December 2015 I wrote the first of what will hopefully be a very long series of annual forecasts for the FTSE 100, FTSE 250, S&P 500 and UK housing market.
That first article forecast the value of the FTSE 100 at the end of 2016 and – miracle of miracles –was just about spot on.
If you ask most people what the UK national grid is, they’ll probably say something about it being the electricity grid.
What they’ll have in mind is a network of pylons, cables, transformers and other such infrastructure which enables the transmission of power from power stations to homes and businesses around the country.
I think that’s a reasonable description and National Grid PLC is the company that owns and operates that infrastructure. If you also include the transmission and distribution of gas in that description, as well as a significant and similar business in the US, then you’ll have a fair summary of what National Grid PLC does.
As you might expect, building, maintaining and managing the electricity and gas network is a very defensive business. Booms and busts may come and go, but people still need to cook, heat their homes and boil their kettles. So it should come as no great surprise that the financial crisis had relatively little impact on the company or its progressive dividend.
That progressive dividend, combined with its recent near-5% dividend yield, is why I decided to take an in-depth look at National Grid.
What I found was a very unusual company operating as a state-appointed monopoly, and you can read my full review in the January issue of Master Investor magazine.
When TP ICAP joined the UK Value Investor model portfolio in 2011 it was called Tullett Prebon and was the second largest interdealer broker in the world behind ICAP PLC.
I invested in Tullett Prebon for the usual reasons: it appeared to be a good company whose share price was depressed by what I hoped were some hopefully short-term problems.
Although the company had an excellent track record of growth, in my original analysis I mentioned that its rapid growth may have been driven by the pre-2009 boom in financial markets rather than by any enduring traits of the company itself.
In the end, and after a five-year holding period, I think that somewhat pessimistic viewpoint was largely correct; Tullett Prebon was a good company, but its pre-2009 growth rate of more than 20% per year was not sustainable in the post-financial crisis world.
After 2009 the company’s fortunes began a decline which continued beyond its entry into the model portfolio in 2011 and has only recently shown signs of slowing down.
Tullett Prebon did not perform as well as I had hoped, but it wasn’t a bad investment.
However, at today’s share price, I see no compelling reason to continue to hold and so at the start of January, I sold the entire position. The overall results are below and, as I said, they are not quite as I hoped for but are nonetheless not too bad:
Purchase price: 359p on 05/09/11
Sale price: 469p on 06/01/2017
Holding period: 5 Years 4 months
Capital gain: 29.2%
Dividend income: 27.8%
Total return: 57%
Annualised total return: 9.3%
Those simple statistics do not quite do the investment justice as it was a bumpy ride from the very beginning. The share price chart below should give you a better idea of how the investment actually went:
A bumpy journey on the way to a satisfactory destination
Note: The sell price in the chart is 433p as that was the price when I did the sell analysis. By the time I sold a few days later, the price had jumped up to 469p.
Buying: The financial crisis and regulatory change create a buying opportunity
In the years before Tullett Prebon joined the model portfolio it had exactly the kind of track record I look for. It had a long history of revenue, earnings and dividend growth, and that growth was relatively consistent as well.
Consistent and rapid growth usually produces a premium share price and that was the case here, with Tullett Prebon trading as high as 525p per share back in 2008.
Consistent and rapid growth over many years
But then the financial crisis arrived, the shares fell below 150p, and the interdealer market changed forever.
Unfortunately, I wasn’t looking for defensive value stocks back in 2009, otherwise, I might have invested in Tullett Prebon during the crisis at that 150p price point. Instead, I was investing in “net net” stocks, companies selling for less than the value of their fixed assets minus all liabilities (a crude approximation of their liquidation value, and a favourite metric of Ben Graham).
By 2011 that had changed and I was in the early days of becoming a defensive value investor, but my approach was very different to the one I use today. I didn’t look at profitability, dividend growth, capex ratios, or any number of other factors that I now take into account. In fact, my approach was much closer to the one detailed in Mary Buffett’s book, The New Buffettology.
I focused on calculating a company’s rate of return on retained earnings and then using that to project future earnings and dividend growth over the next few years. Armed with future growth rates, I could then calculate an “expected” future share price based on the company’s historically average PE ratio.
Somewhat embarrassingly, my projection in 2011 for Tullett Prebon’s 2016 share price was 1,484p; not exactly close to my eventual exit price of 469p.
That was the somewhat optimistic basis for the investment, but I wasn’t completely optimistic and did know about some of the major headwinds the company was likely to face in the years ahead.
These were primarily the financial sector’s reduced appetite for speculative trading and impending tighter regulations on the all-important OTC (over-the-counter) financial markets (in my opinion both welcome side effects of the financial crisis). So it wasn’t all sunshine and rainbows, but the outlook was rosy enough for me to invest.
The table below compares the 2011 versions of Tullett Prebon and the FTSE 100 using my current metrics (which you can calculate yourself for any suitable company using these investment spreadsheets). Even though I didn’t use these metrics at the time, the company still comes out looking attractive relative to the market.
In 2011 Tullett Prebon beat the FTSE 100 on almost every metric
Holding: Known headwinds prove to be stronger than I had expected
The investment in Tullett Prebon did not exactly get off to a flying start. Within a few short months, the share price had fallen by more than 25% and the Chief Operating Officer had resigned. However, more important than share price movements or musical chairs in the boardroom were the company’s unfolding results, which were consistently negative.
This initial period of weak results is entirely normal in the world of value investing; after all, companies usually only become attractively valued when they are facing obvious problems of one sort or another. Generally, a best-case scenario is that both the problems and the depressed share price are short-lived.
In this case, the initial period of weak results continued into 2012, 2013, 2014 and, to a lesser extent, 2015.
For example, the 2012 results were neatly summed up by the Chairman:
“Market conditions remained challenging throughout 2012 as the overall level of activity in the financial markets remained subdued.”
And the CEO had this to say:
“Our customers are operating in a more onerous regulatory environment and there is considerable uncertainty over the impact of new regulations covering the OTC markets. It is therefore prudent to expect that financial market activity will continue to be subdued.”
Subdued activity is not good for a broker, and this was reflected in the company’s declining revenues and earnings.
In 2013 the CEO’s statement was almost identical, as was the decline in the company’s results:
“The overall level of activity in the financial markets that we serve has been subdued for the last eighteen months reflecting persistently low volatility, the more onerous regulatory environment for our customers and the considerable uncertainty over the impact of new regulations covering the OTC derivatives markets, particularly in the United States.”
That statement was then largely repeated in 2014.
Despite the gloom, one helpful aspect in the face of falling revenues was the company’s relative lack of fixed overheads.
Instead of huge factories filled with expensive machinery, “voice” brokerages like TP ICAP generate revenues primarily through a mixture of humans, telephones and technology, with humans being one of the largest and most flexible parts of the cost structure (in 2013 broker compensation was equal to more than 50% of broker revenues and came to an average of £259,000 per broker; nice work if you can get it).
This is helpful in a downturn because costs can be reduced almost in line with revenue declines (i.e. brokers can be laid off), and that reduces operational gearing and helps maintain earnings in the face of lower revenues.
While low operational gearing helped the company avoid a collapse in profits, it was not enough on its own to turn things around. For that, the company looked to major acquisitions.
The first major acquisition was PVM Oil Associates in 2014 and then, much more importantly, ICAP’s voice brokerage business in 2016, which roughly doubled the size of the group.
These acquisitions are intended to be transformative, but I am not the sort of investor who pins their hopes on an unproven future and so they did not sway my decision to remove TP ICAP from the portfolio.
The company’s post-crisis results were less than spectacular
Selling: A weak track record and higher share price provide few grounds for optimism
So why have I decided to sell now? The main reason is, as usual, that TP ICAP is now ranked lower on my stock screen than almost any other holding in the portfolio, with only BAE Systems having a lower rank. This change in the company’s relative attractiveness has come about for two reasons.
The first reason is that its financial track record has completely changed from the high growth record it had in 2011. The company’s results have declined almost every year since 2009 and that has had a massive impact on its growth rate, growth quality and profitability metrics.
The second reason is that while the company’s financial results have been declining, its share price has increased. As a result, its valuation ratios are no longer attractive given the company’s unimpressive track record of recent years.
The table below compares Tullett Prebon at the time of purchase to TP ICAP as it stands today:
Today the company’s stats are far less impressive than they were
Overall, the company’s combination of financial results and valuation ratios is far less attractive than it was five years ago.
However, I don’t just mechanically sell when the stock screen tells me to. I like to think at least a little bit about what the future might hold for a company, and in some cases, if I’m particularly optimistic I might hold on for a while longer, even if the company’s stock screen rank is not that appealing.
In TP ICAP’s case, I might have argued that a weakening financial track record is normal in cyclical companies, especially if they are purchased after a cyclical boom which is then followed by a cyclical bust. I might then have held on in the hope that the cycle would soon turn towards a boom, driving revenues, profits and share prices upwards.
In fact, I do think TP ICAP is caught in a cyclical downturn, but I also think it could be a very long time before we see another financial sector boom.
I could be completely wrong, but my understanding is that credit-driven financial crises can take many many years to recover from, rather than just several years, so TP ICAP’s turnaround could be a very long way off.
In summary, TP ICAP’s track record is not great, its price is not great and there is no obvious reason why things are going to get better anytime soon. That, in a nutshell, is why I’ve sold.
The proceeds will be reinvested into a new holding next month, following my usual portfolio maintenance strategy of buying or selling one holding each month.
Hopefully, the new company will return something better than the reasonable but unspectacular 9% per year that TP ICAP has returned these past five years.
I’ll leave the final word to TP ICAP’s Chairman, taken from the 2015 annual report:
“It is not possible to predict when the structural and cyclical factors currently adversely affecting the interdealer broker industry will ease, or when the level of activity in the wholesale OTC financial markets may increase. Our recent performance has benefited from the buoyant level of activity in the Energy and commodities markets, particularly in oil and oil related financial instruments, and this level of activity may not persist.”
Note: Tullett Prebon joined the model portfolio before I’d started publishing the UK Value Investor newsletter, so the original pre-purchase review appeared in this 2011 blog post instead.
Every year throws up many valuable investment lessons, and 2016 was no different.
For me, these investment lessons come primarily from the companies I buy and sell, both winners and losers, mistakes and successes.
I uncover these lessons by writing a post-sale review at the end of every investment. My hope is that these lessons can then be incorporated into my investment strategy to make it, and any real-world portfolios which use it, perform better in the future.
Recently I published a 2015 investment lessons ebook to bring all of 2015’s post-sale reviews together into one document.
That seemed to be quite popular among readers of this blog, so with 2016 over I’ve decided to do it again by collecting together all of the post-sale reviews from 2016 into a single, downloadable ebook.
The end of 2016 was an important milestone for the UK Value Investor model portfolio. It marked the end of the portfolio’s fifth full calendar year and so at last it is beginning to build up a meaningful performance track record.
I say “meaningful” because stock market returns over periods of less than five years are little more than random noise. In fact, I think an investment manager or methodology really needs a track record of ten years or more before you can say anything robust about its performance.
And so with five calendar years in the bag, the end of 2016 is a good point to look back and review the portfolio’s toddler years.
In this year-end review, I’ll be looking back at the ten blog posts with the largest number of views in 2016.
But first, I should mention that I was going to start this blog post off with an extended look back at 2016 as a whole.
I was going to mention Brexitand Trumpand the fact that, quite fittingly, Merriam-Webster chose surreal as their word of 2016, where their definition of surreal is “the intense irrational reality of a dream”.
But then I changed my mind.
So instead I’ll just crack on and do a Top of the Pops-style countdown of the ten most popular UK Value Investor blog posts of 2016:
In at number ten is this FTSE 250 forecast from January 2016, forecasting both fair value and expected value for the end of 2016.
My quantitative forecast of fair value (the level at which the FTSE 250’s CAPE ratio is equal to its historic average) was 15,338 (or 15,300 to a more realistic level of accuracy).
For expected value (the level you might reasonably expect the FTSE 250 to have at the end of the year, averaged across all possible alternative futures) was 16,700.
How did those forecasts work out?
Well, currently the FTSE 250 is at 17,900, so it’s still above both my fair and expected values, which means I’m likely to be slightly bearish next year as well.
Important point (!): These forecasts are indicative forecasts rather than concrete predictions because, as every good investor should know, the future is a volatile, uncertain, complex and ambiguous place.
Number nine is a blog post written in early 2015. It remained a favourite in 2016 though, largely due I think to the blatant use of Fundsmith as the main topic.
I found that Fundsmith’s accumulation units had seen dividend growth of around 12% per year since 2010 compared to unit value growth of 18% per year. I think the former is potentially sustainable while the latter is unlikely to be sustainable.
The blog post at number eight can be summed up with a quote: “I made a big mistake with this investment”. Warren Buffett said that about Tesco and I feel the same way. However, having sold it in 2016 for a near-50% capital loss, there were some important lessons to be learned and this post-sale review covers the most important ones.
At number seven is a post about Glaxo, another major FTSE 100 company which has been in my model portfolio since 2015. Its share price has increased since the blog post was published and the yield is now a mere 5.2%, but the company and share price still look very attractive to me.
At number six is a review of the model portfolio from the start of the year, looking back at how it performed over the previous five years relative to the FTSE All-Share.
At that stage, the “Brexit bounce” lay in the future and the model portfolio was performing well relative to an All-Share index which had been flat for over two years.
Number five is a review of a company where I’m actually positive (I often get accused of being negative about most of the companies I review, which is a fair comment because, in my opinion, most stocks are not especially good investments).
I continued to be positive about Next throughout the year and recently bought shares in the company.
I guess there had to be something about Brexit in the top ten somewhere and here it is at number four. My Brexit survival plan may not actually be very secret, but it is easy to implement.
At number three, it’s the UK housing market. This topic almost never goes out of favour, especially after a twenty-year bull run.
I remain persistently bearish (and so far persistently “wrong”) and consider myself one of the few people who are clinically sane when it comes to house prices, especially those in London.
Perhaps “surreal” is a good description of London house prices as well as Brexit and President Trump.
At number two it’s my 2016 forecast for the large-cap FTSE 100 index, published in December 2015. As usual, it’s based on the CAPE ratio and has a year-end forecast for both fair and expected value.
The fair value forecast was 8,160 (or more reasonably: 8,200), showing that the index was and is below fair value.
The expected value forecast was slightly lower at 7,100.
With the FTSE 100 currently standing at 7,060 this looks like a surprisingly accurate forecast, although of course that is mostly due to luck rather than the mystic power of my non-existent crystal ball.
And here it is; the most-read blog post of 2016. It’s a mid-year review of the FTSE 100’s value, although this time without the forecast. This one has some nice charts if I do say so myself, including the infamous “rainbow chart”.
Also of particular note was the FTSE 100’s uncovered dividend, which does not bode well for the index’s dividend growth over the next year or so.
Tate & Lyle PLC no longer runs the branded sugar or syrup businesses it’s famous for, but the company is still an interesting and relatively defensive option for many investors.
With its shares trading at 675p Tate & Lyle’s dividend yield is 4.2%, which is slightly above the FTSE 100’s yield of 3.8% (with the index at 6,900).
That high yield is attractive, especially for investors who are fond of dividends, as I am. Another positive is that the company paid a dividend in every one of the last ten years, and also increased that dividend almost every year.
However, despite its attractive dividend yield and dividend history, I won’t be buying any Tate & Lyle shares at their current price. Here’s why.
Most people I speak to think that UK house prices are ridiculously high, especially in London.
Admittedly, this is not a novel idea. However, as a very minor student of bubbles, I think it’s worth thinking through the possible implications.
So in the rest of this post, I want to outline a) why I think we’re in a house price bubble and b) what the implications might be for the future of house prices in the UK.
Super-high-yield investing involves buying shares where the dividend yield is close to or above twice the market yield. Of course, this means taking on more risk, but the returns can be much greater as well.
For example, when I bought UK Mail in 2011 it had a yield of 8.6% because the market expected a dividend cut. The cut never came and within a year I sold UK Mail for a total return of 32%.
An even faster re-rating occurred after I bought N Brown in 2012 with a yield of 5.4%. Just eight months later the share price had increased by 47% and I sold N Brown for a total return of 52%.
Although I don’t invest in many of these situations they have, on average, worked out quite well over the years. The trick, of course, is to try to separate out those companies that can sustain the dividend from those that are about to cut or suspend it.
In November’s Master Investor magazine, I reviewed three super-high yield companies (N Brown, Carillion and Connect Group) in order to highlight some of the factors I look at in order to separate out the wheat from the chaff.
There are no guarantees of course, but hopefully you’ll find something useful in there.
While some investments are difficult, others are easy, and my recently ended investment in Homeserve PLC was definitely of the second kind.
Buy low, sell high. What could be simpler?
As the chart above shows, this was a classic value investment: 1) Buy a good company at a time of difficulty and when other investors are pessimistic; 2) hold while the company and its situation improve and then; 3) sell when other investors become optimistic.
When I looked at Homeserve in 2013 it had a long track record of financial success, but the announcement of an investigation by its regulator in 2011 had unnerved the market and sent the shares crashing by around 50%.
Having investigated the company in some detail I thought the odds were good that it would continue to prosper in the longer term, so I added it to my defensive value model portfolio and personal portfolio.
As luck would have it I was right, and so after a relatively short three-year holding period, I have decided to sell in order to lock in some impressive and largely unexpected gains.
Dividends tend to rise faster than inflation, and that could become their most attractive feature if the value of the pound and the interest rate on savings keep falling.
With inflation in mind, I decided to focus my latest article for Master Investor magazine on a handful of UK stocks that combine a decent dividend yield today with super-consistent and inflation-beating dividend growth.
What I learned from analysing them is that – unsurprisingly- very few stocks can combine consistent past growth with a decent dividend yield today and bright future prospects.
Most of those five companies have problems of one sort or another, although having said that, I do hold The Restaurant Group and British American Tobacco in both the UKVI portfolio and my personal portfolio.
You can download just the article or the entire Master Investor magazine (which this month is about how to protect your portfolio from inflation) using the links below.
Most investors make regular investments into their portfolios as they work towards retirement.
But what’s the best way to do that? Should new money be used to buy more holdings or to top up existing holdings?
And if it’s going to be used to top up existing holdings, which ones should get the additional investments?
This is a topic I get asked about on a regular basis, so in this article, I’ll explain the rules I follow when making regular investments in my own portfolio, with an emphasis on keeping diversification up and risk down.
In this review of the UKVI portfolio, I’m going to look at three things: Setting appropriate performance goals, tracking performance and lowering risk.
But first, a few general points:
The portfolio holds 30 stocks, split about 50/50 between the FTSE 100 and FTSE 250, with one or two incidental small-cap companies
For the last few months, I’ve been writing a regular column for Master Investor magazine called The Dividend Hunter.
I haven’t mentioned it here because I wanted to see if the collaboration would last, i.e. whether or not my articles were good enough for the magazine!
So far they seem to be, so from now on I’m going to link to each monthly Dividend Hunter article as it’s published.
Since there are already a few in “print” I’m going to link to all of them here, but going forward it’ll be just the latest one.
