My thoughts on dividend strategies

Ben Hobson recently wrote an article entitled “Ten FTSE 350 stocks for dividend growth investors” (http://is.gd/x4yQCR). Back in 2013, Stephen Bland wrote an article about the HYP strategy (http://is.gd/TaJuHf)

My understanding is that the HYP strategy aims at providing an annuity, nothing more, nothing less. Specifically, it is not about dividend growth, capital growth, or even capital preservation.

Having lost my job recently in the Oil & Gas industry, I have been looking to add some dividend stocks to my portfolio. A couple of recent additions have been: * IMT – Imperial Tobacco
* PAY – Paypoint

I also liked the look of IGG (IG Group), although I haven’t added it. It’s early day yet, but my holding in IMT is currently under water (-2.4%), whilst my holding in PAY is up 9.0%. The timing of my holding in PAY was completely fortuitous, having bought a crunch in the shares which recovered quickly. Buying doesn’t always work that way, of course, as I’ve bought at least my fair share of companies that fell out of their pram the very next day.

IMT and PAY are both in Neil Woodford’s portfolios, giving added assurance that the choices are reasonable. My selection criteria is based on Pyad’s screen. I look for: * net debt <= 0
* Yield % >= 1.1 market median
* industry excludes collective investments
* is a primary listing

That gives me a list of shares as a starting point. Unlike the Pyad screen, I’m not trying to hunt the bargain bucket. I am looking for genuine quality, and I am willing to pay up and accept a lower yield to obtain it.

My general thoughts on dividend strategies is as follows:
* looking for “dividend achievers” is no panacea. Lynch said that you could “hardly lose” with dividend achievers. Having seen an alarming number of dividend achievers crash and burn (e.g. Tesco, Albermerle & Bond, Balfour Beatty, and countless others), I’m not a huge fan of using this criterion
* dividend cover is no panacea, either. In virtually every article you see about dividend investing, they will mention dividend cover as a way of assessing sustainability. My view is that dividend cover is a very unreliable measure. Consider housebuilder BWY (Bellway), for example. Its cover never dipped below 2, yet it slashed its dividend as a result of the credit crunch. Talking of which …
* cyclicals. Cyclical companies really muddy the waters when it comes to selecting dividend stocks. It is all too easy to buy into high-yielding cyclicals that deteriorate rapidly. The dividends may have been raised for half a dozen years, the stock price has recovered magnificently, and a large section of the market either thinks that it is a growth company or safe enough to invest in. It’s a recipe for buying the tops, which of course we want to avoid.
* debt; by which I mean lack thereof. My own feeling is that this is the biggest single safety factor there is. Too often, companies will load up on debt, particularly if they are run by spivvy city types. This will provide nice increases in earnings and growing dividends, which the market will lap up. Unfortunately, the underlying economics of the company may not be all that good, and if things go wrong, the debt could prove too much. Dividend investors stand the risk of hopping on board at the wrong moment, only to see their shares tank. Basically, the market was aware of some problem that the dividend investor hadn’t picked up on
* growth. This is something of a debatable topic, but I think that investors should really be looking for companies with actual growth prospects, rather than those that will just bump along. They don’t have to be rapid growth, just companies that can chug out the numbers year after year. So I’d likely avoid big Footsie companies, whose best days are probably behind it, and are probably over-indebted anyway.

You can see why Terry Smith likes companies like DOM (Domino Pizzas), for example. Although not really a growth stock, on account of its high rating, earnings have grown from 4.78p to 26.4p over the last decade, yet it still has net cash.

Another good company, but again the shares are too highly rated, is DPLM (Diploma). Its earnings have risen from 9.32p to 36.10p over the last decade and it, too, has net cash.

These sorts of companies are obviously doing (or at least did) something right. They have found productive uses for their capital, and have been obtaining acceptable returns on capital. If you can find those sorts of companies where the yield is above 3%, I think you are very likely to do well.

The sorts of companies that I, personally, would tend to avoid are “traditional” dividend stocks, even if they are owned by Neil Woodford. I don’t like utility stocks, for example. They require a lot of debt, are regulated, and are unlikely to grow much (but there do seem to be exceptions).

Anyway, that’s my 2 cents.

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About mcturra2000

Computer programmer living in Scotland.
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