Recent tips – Dividend Portfolio 5
In today’s post we look at some recent articles reminding us to stick with dividend investing during a bear market.
It’s a change to our scheduled programming today. I had planned to look at high-yield investment trusts that might be suitable for our dividend portfolio, but events, dear boy, events have got in the way.
The bear market for stocks and the dodgy outlook for many famous dividends in the UK have lead to a rash of articles over the past few weeks reminding us to stick with dividend investing through thick and thin, and also to check that the yield is safe.
So today we’re going to look at what people have been saying, and which stocks their filters have been throwing up. I hope that by the end of the article we’ll have put together our own watch list.
The first message is obvious but always worth repeating. Don’t sell your stocks at the bottom.
I mentioned earlier this week how bad I am at predicting market falls. The time to sell some of your portfolio, or to hedge your exposure was back in April, with the FTSE-100 over 7,000.
Just because it’s fallen 20% in the interim doesn’t make it more likely to fall another 20%. That’s recency bias.
Phil had two articles about dividend investing over the past few weeks:
Both are worth a read in full, but I’ll focus today on the recommendations for putting together a dividend portfolio.
Phil harks back to Ben Graham’s advice about buying stocks:
- buy bigger, more established companies with a long history of profits and dividends
- avoid too much debt
- avoid high PE ratios (price above 15 times 3-year average earnings)
- avoid high price to net asset values (P/NAV less than 1.5)
This was great advice in Graham’s day, but Phil found only one firm in the FTSE-350 met Graham’s defensive tests.
Phil’s adapted screen
So Phil adapted the screen for today:
- FTSE 350 stocks only
- 20 years of dividend payments
- no losses for 20 years
- current dividend yield of 3% or more
- note that we want a bit more than that, a 3.5% minimum
- forecast dividend cover of 1.2 times or more
- a bit low for us, though Phil explicitly states that this is to avoid eliminating utilities
- interest cover of at least three times
- this is the test of whether there is too much debt
- higher dividend per share now than 5 years ago
- coupled with the dividend cover test, this implies reasonable earnings growth
- forecast dividend for next year at least as high as this year
- no dividend cuts are forecast
This is quite the list of filters, but using SharePad, Phil still came up with 33 stocks, shown in the table below.
Comparison to 7 Circles
You’ll remember that a couple of weeks ago we ran our own screen, using the Hargreaves Lansdown screener and five filters:
- market cap >= £500M
- yield >= 3.5%
- PE <= 19
- dividend cover >= 1.5 times
- historical dividend growth of 5%
Two weeks ago this produced 30 stocks.
- Unfortunately today the HL screener is not available – we’ll need to check again next time to see if it’s gone for good.
The other screeners we looked at (Google Finance and the FT) didn’t have the dividend cover filter, so we will need to calculate it.
Calculating dividend cover
We can calculate dividend cover from the dividend yield and the PE ratio:
Dividend cover = earnings / dividend
Dividend yield % = dividend / price * 100 PE ratio = price / earnings
1 / PE = earnings / price
This is the earnings yield.
(1/PE) / Yield = earnings / price = dividend cover
Let’s work through an example using our filter criteria of maximum 19 PE and minimum yield 3.5%:
1 / PE = 1 / 19 = 5.3%
Dividend cover = 5.3% / 3.5% = 1.5 times
So with our edge criteria, the ratio works out fine.
- If you remember, this is how we worked out that a PE of 19 would be the highest we were interested in.
Now let’s try again with a lower PE and a higher yield, say 15 and 5% respectively:
1 / PE = 1 / 15 = 6.7%
Dividend cover = 6.7% / 5% = 1.3%
So this now fails our strict test, though it’s above Phil’s minimum dividend cover of 1.2.
- The higher the yield, the lower the PE needs to be.
The table below shows the maximum acceptable PE for yields from 3.5% to 8%.
Here’s the screen I used:
- market cap >= £500M
- yield >= 3.5%
- PE <= 19
- Price to book <= 3
- Price to sales <= 3
That gave me 48 stocks initially:
- It turns out that using PE <=19 returns stocks with no PE data
- So I excluded 12 stocks for now, even though I’m not convinced that all were loss making
- 4 stocks were removed for having dividend cover of less than 1.2 times
- 1 stock had data errors and was removed
This left 31 stocks, of which 8 had dividend cover of between 1.2 times and 1.5 times.
There is little overlap between Phil’s list and mine – only 8 of his 33 are amongst my list of 31
- I assume this is down to Phil not including any valuation criteria
- By contrast, my filter doesn’t look at the track record of dividend payments and growth, or the years of constant profits.
I also don’t have any assessment of the level of debt.
- When I add interest cover of 3 times minimum, my list is reduced to 22 stocks, 7 of which were on Phil’s list.
We’re cutting it fine, but this is still enough stocks for a portfolio, which would have:
- an average PE of 13.6
- yield of 4.3%
- dividend cover of 1.8
- price to book of 1.9
- price to sales of 1.0
High dividends or dividend growth
Phil’s second article was on whether high yield was preferable or not to growing dividends.
- Phil’s mantra is to ignore stock prices and focus on the stability of dividends, which are hopefully also growing over time.
He compared two hypothetical portfolios over the previous year (starting in Feb 2015):
- the 20 FTSE-350 stocks with the highest yields
- the 20 FTSE-350 stocks with the highest rates of dividend growth
The first portfolio is similar to the ‘Dogs of the Dow’ strategy from Michael B O’Higgins.
- For a while this was a great plan, but over the last 20 years it hasn’t worked so well
Over the last year, the Dogs made 6.14%, compared with -6.6% for the FTSE All Share over the same period.
The Growers (yield >= 3%, dividend growth >= 5%) made 14.2%.
Based on these results he put together a new screen (which I will call Oakley 2).
- this added dividend cover of 1.5 times and dividend history of 10 years to the Growers screen.
Here are the 20 shares he chose:
Phil plans to track this portfolio in the future, and it will be interesting to see what happens.
The 7 Circles list includes 4 of the Dogs, 5 of the Growers and only 3 from the “Oakley 2” screen.
- once again I assume that the relatively low overlap is down to Phil not using any valuation screens
The contrast with Phil’s articles couldn’t be greater. Apart from the overlap between the two lists (since the FTSE 350 includes the FTSE 100), the screen they used was just dividend yield.
As you can imagine, there are quite a few beaten down resources and energy stocks on the lists whose future dividends are doubtful to say the least.
I have no idea who these “articles” are aimed at, or who might find them useful.
Our next port of call is The Dividend Drive, a blog which is not surprisingly about dividend investing.
At the end of the year the author reviewed his portfolio, which I think is worth a quick look:
It’s a 34 stock portfolio, of which four are listed in the US.
- only three of the 30 UK stocks appear on our short list – Legal & General, Old Mutual and National Grid
I think that many others will be hiding in my existing portfolios, not explicitly labelled as dividend stocks.
- we’ll pop back to check when we look through the existing portfolios (see Conclusions, below)
Here are the main points from the January 2016 report:
- 2015 UK dividends totalled £87.6bn, but growth slowed steadily through the year
- this is down 10.0% from 2014, when Vodafone’s issued a record special dividend
- underlying dividends (ex specials) were £84.6bn, up 6.8%
- 40% of UK dividends are declared in US dollars; the stronger dollar added £2.5bn to the 2015 total
Dividend cuts were a big feature in in 2015, but there are more to come:
- Supermarkets have slashed payouts as profits are hit by a price war
- Oil majors are holding firm to date
- The commodity crash and collapse in mining profits will cause dividend cuts in 2016
- Financial dividends look strong (Lloyds, real estate, and insurance companies)
- Consumer companies are increasing payouts
- Pharmaceutical dividends are up only 2.2% since 2012
Equities are set to yield 3.9% for 2016, with the first fall in underlying dividends (0.9%) since 2010
The last two charts show the split of dividends by size of company, in two ways:
This is all good stuff, but it’s worth remembering that analysis of UK dividends in aggregate is a market cap-based approach.
- When we put together our own portfolios, we are using an equal weight approach
- It doesn’t matter how many dividends are paid out in the UK as a whole, only that we can find 20 companies spread across industry sectors with high and safe payouts
As we’ve seen from looking at Phil Oakley’s screens and the Dividend Drive portfolio, there’s more than one way to skin a cat.
- For now I plan to stick with an approach that combines yield, interest and dividend cover and price / value
The next steps are:
- Carry out an “X-Ray” of my existing portfolios to see which dividend stocks may be hiding there
- Combine these with some of today’s shortlist to produce a portfolio with sector diversification
- Look at high-yielding investment trusts that can be added to the portfolio
Until next time.