Dividend Dogs of the FTSE 100: Six stocks for dividend hunters

Wednesday, Dec 07 2011 by
10
Dividend Dogs of the FTSE 100 Six stocks for dividend hunters

Stocks have paid a heavy price for the economic turmoil that has ravaged London markets during the second half of this year but it hasn’t all been bad news. A direct consequence of depressed market caps is that those companies that continue to pay dividends look all the more attractive. Indeed, for investors chasing income, the conditions have provided an ideal hunting ground for buying into some of the best dividend payers in the market – but how do you find them?

Screening for high yielding stocks is nothing new; in the early 1990s Michael O’Higgins and John Downes popularised the approach in their book Beating the Dow. Their Dogs of the Dow technique stripped away conventional metrics such as EPS growth and PE ratios and focused simply on who was paying what. The idea was that by backing a mechanically selected basket of stalwart income generators, investors could insulate themselves from the vagaries of the market and still make a profit.

The technique involved taking the 30 stocks that make up the Dow Jones industrial average, filtering them for the 10 highest dividend yields and then investing an equal sum in each stock. The appeal of this approach is its simplicity – you simply take a company’s current annual dividend per share and divide it by the stock price. In terms of housekeeping, O’Higgins and Downes urged that the 10-strong portfolio be revised once a year based on an updated list of high yielding stocks.

Rising dividends

With market volatility providing fewer and fewer opportunities for all but the bravest investors, a dividend screen – in this case the Dogs of the Footsie – offers an intriguing option. Scrutinising large, mature and relatively safe companies means investors can put less emphasis on market reaction and sentiment and focus more on finding attractively priced dividend payers. The screen theoretically offers a conservative option that produces a list of well financed companies that have long histories of weathering economic turmoil.

The technique has added resonance at a time when market conditions are weak but dividend levels are rising. According to Capita Registrars, the rolling historic yield for the FTSE 100 (UKX) for the four quarters up to the end of Q2 2011 was 3.4%. The forecast for the whole of 2011 is 3.6%. With a list defined using Stockopedia Premium, the top 10 stocks offer yields starting from 5.16% and rising to 9.54% - so it may be time to consider ditching the tracker fund.

Watch for the detail

Before discussing the Dogs of the FTSE screen results, it is worth noting some potential downsides. The main criticism of the technique is that an annual review of the portfolio is likely to mean making some major changes thus triggering potentially high trading costs and possibly crystallising capital gains taxes.

Another health warning is that by using this technique, investors are relying on historical dividend yields as the basis of making investment decisions. Analysts have been quick to point out that while high yields may simply point to out-of-favour stocks, those yields are susceptible to being cut. To try to deal with that, we have overlaid the Dogs of the Footsie screen with the Dogs of the Footsie Forecast screen, which means we have compared historical yields with forecast yields, but the latter in turn is reliant on analyst dividend forecasts being accurate (which - as we've discussed elsewhere - they generally aren't!). Interestingly, eight of the 10 companies – all of them FTSE 100 stocks – appear on both screens.

The first of them is Royal & Sun Alliance Insurance (LON:RSA) which, with a current dividend yield of 8.09% is among a number of financial giants on the list, including fellow insurers Man Group (LON:EMG), Aviva (LON:AV.) and Standard Life (LON:SL.). Shares in RSA reached a 12 month high of 135p in May but the stock has since fallen to around 108p. Nevertheless, the full year dividend was increased by 7% to 5.70p, reflecting what CEO Andy Haste said was the company’s confidence about its outlook. 2010 was a difficult year for insurers generally, with higher than normal weather-related losses. RSA has insisted that a focus on emerging markets, where it is already seeing double digit growth, will prove to be a key factor in its future performance.

Meanwhile, BAE Systems (LON:BA.) is the only industrials business on the list, with a current dividend yield of 6.35% helped by a share price that has slipped from 340p to 277p since January. BAE increased its total dividend by 9.4% to 17.5p in 2010 despite concerns about a slowdown in sales at its Land & Armaments division caused by pressures on defence budgets, particularly in the US and UK.

For energy company National Grid (LON:NG.), last year proved to be a strong one, with pre-tax profits up by 25% to £2.5bn contributing to an 8% rise in the dividend to 36.37p – in line with its policy of targeting 8% growth until March 2012. National Grid’s obligations to engage with regulatory changes in its UK and US businesses and upgrade gas and electricity supply infrastructure saw it spend £3.6bn on capital investment last year. Shares in the group have risen from 515p to 601p in 12 months, meaning that the current yield stands at 6.02%.

Elsewhere, Astrazeneca (LON:AZN) is the only pharmaceuticals group to make it onto the Dogs of the FTSE list, although 2011 will probably be a year to forget for both the company and its investors. Shares in group have hurtled between 3126p and 2595p this year but its current price of 2942p is largely where it was 12 months ago. News from the company has been mixed but it remains of major interest to investors – qualifying for nine value, quality and income stock screens on Stockopedia Premium. Last year the company increased its dividend by 11% to 161.6p – representing a current yield of 5.57%. Overall cash distributions to shareholders through dividends totalled £2.2 billion.

Next, real estate group British Land (LON:BLND) scrapes into the Dogs of the FTSE list with a current yield of 5.16% on a dividend that was maintained last year at 26p. Macro economic woes have been tough on British Land’s retail business of late but the Central London office market has been more robust. Shares in the company have been volatile this year, reaching a high of 614p in July but currently trading at 490p. The stock lost 59p during two weeks in November but then went on to claw most of that back during the following five days.

Finally, depending on which day you look, telecoms giant Vodafone (LON:VOD) sits just on the edge of the Dogs of the FTSE list with a current yield of 5.14% after increasing its dividend last year by 7.1% to 8.90p. Shares in Vodafone have traded in a fairly narrow range of between 155p and 166p through most of 2011 but have recently managed to break through 170p. Exceptional dividend payments due next year following a maiden pay-out from its part-owned US arm Verizon, skew Vodafone’s yield forecasts. However, the company has said that it expects that total dividends per share will be no less than 10.18p for the 2013 financial year.

Extra care

As ever, a screen like this is just the starting point for further research. All of the stocks highlighted here have Piotroski F-Scores of between four and six out of a possible nine – so nothing spectacular but putting them in the mid-range on a scale that measures the health of potential value investments. In terms of dividend cover, which is the ratio of a company’s net income over its dividend and which can indicate how sustainable a dividend actually is, the findings are more mixed. Dividend cover of less than 1.5x may indicate a danger of a dividend cut while more than 2x is usually viewed as healthy. All these companies have cover between 1.65x and 3.66x (except RSA where it has been falling for four years and currently stands at 1.1x). Finally, BAE Systems is the only company where there appears to be a possible red flag according to the Altman Z-Score. As bizarre as it may sound for what is widely seen as a defensive play, BAE looks to have an Altman score below 1.8 meaning that some aspects of BAE’s financials resemble those of companies that have gone under. Then again, the Altman Z-Score does also produce false positives, so this may be the case here. 

For dividend hunters, the Dogs of the FTSE screen offers an interesting starting point for selecting hitherto reliable income generators that are well used to fending off market volatility. The advantage of applying the screen in the current climate is that investors are not only buying into dividends but they are also acquiring attractively priced blue chip stocks that are likely to enjoy capital gains when market conditions begin to improve. However, even with the addition of the forecast yields screen, the uncertainty surrounding the eurozone and the prospect of another UK recession means investors would be well advised to approach the results with care. We will be tracking the screen's performance on Stockopedia Premium

Of course, we'd welcome thoughts & views on this strategy using the comment box below. As a reminder, you can sign up for the Stockopedia Premium beta site!


Filed Under: Dividends, Income Investing,
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    RSA Insurance Group plc is the holding company of the RSA group of companies whose principal activity is the transaction of personal and commercial general insurance business. The Company operates in four segments: Scandinavia, Canada, United Kingdom and Western Europe, and Emerging Markets. The Company provides insurance covers for a range of renewable energy technologies, including Wind Energy, which includes onshore and offshore facilities; Solar Energy, which includes photovoltaic, concentrated and thermal installations; Small Hydro, which includes power stations producing an output up to 50 megawatt, and Bio energy, which includes Biomass, Biogas and Waste to Energy plants. The Company works with both large and small brokers. The Company works with partners, such as building societies, banks, retailers, motor manufacturers, charities, utilities and unions to offer their customers appropriate insurance products. more »

    Share Price (Full)
    94.7p
    Change
    2.1  2.3%
    P/E (fwd)
    11.7
    Yield (fwd)
    3.1
    Mkt Cap (£m)
    4,800

    Man Group PLC operates in the alternative investment management sector. The Company has a geographically diverse investor base. The Company offers a comprehensive suite of funds through its performance-driven investment engines to a highly-diversified client base. Its principal operating subsidiaries include Man Investments Limited, Man Investments AG, Man Investments (USA) LLC, Man Investments (CH) AG, GLG Partners LP, E D & F Man Limited and Man Investments Finance Limited. more »

    Share Price (Full)
    100.8p
    Change
    1.2  1.2%
    P/E (fwd)
    13.1
    Yield (fwd)
    5.1
    Mkt Cap (£m)
    1,811

    Aviva plc (Aviva) is an insurance group. Aviva is engaged in the provision of products and services, such as long-term insurance and savings, fund management and general insurance. Aviva provides over 43 million customers with long-term insurance and savings, general and health insurance, and fund management products and services. Its business is managed on four geographic regions: United Kingdom, Europe, North America and Asia Pacific. The four regions, together with Aviva Investors, function as six operating segments. The UK region is split into the UK Life and UK General Insurance segments, which undertake long-term insurance and savings business and general insurance, respectively. more »

    Share Price (Full)
    509p
    Change
    10.0  2.0%
    P/E (fwd)
    10.5
    Yield (fwd)
    3.4
    Mkt Cap (£m)
    15,000



      Is RSA Insurance fundamentally strong or weak? Find out More »


    7 Comments on this Article show/hide all

    UK Value Investor 8th Dec '11 1 of 7
    1

    I'd vouch for a few of these (since I hold them). BAE, AstraZeneca and Vodafone. Aviva certainly looks interesting but perhaps risky.

    I think the altman-z score on BAE is definitely wonky! I really don't see them going under any time soon.

    Newsletter: UK Value Investor
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    Edward Croft 8th Dec '11 2 of 7
    1

    In reply to UK Value Investor, post #1

    UKVI - BAE's Altman Score is definitely in what he calls "the distress zone" - I've verified on different platforms. That of course doesn't mean its going to go bust, just that it shares the same balance sheet qualities as companies that have fallen into financial distress in the past.

    According to various studies, the Altman Z score has been from 72% - 90% accurate.  Investing is a game of probabilities, and its good to know where you stand.  Figuring out whether BAE Systems is at risk or not is one for better accountants than me though!

    Here's a picture from our Altman Popup/Checklist on BAE Systems

    Stockopedia | BAE SYSTEMS Share Price - BA. Share Price Quotes, Charts, RNS & Stock Market News (BA.L, LON:BA.)

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    | Link | Share | 1 reply
    UK Value Investor 8th Dec '11 3 of 7
    1

    In reply to Edward Croft, post #2

    Hi Ed. I totally agree, it's in the zone and I didn't mean 'wonky' as in your data is wonky, I just mean that the metric is very probably giving a false positive.

    I will eat a (very small) hat if BAE goes to the wall in the next 5 years!

    That doesn't mean I think the altman-z is no good, like you say it has a history of success, it's just in this case I think BAE falls into the other 10-28%.

    Newsletter: UK Value Investor
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    Edward Croft 8th Dec '11 4 of 7
    1

    In reply to UK Value Investor, post #3

    I've been thinking an interesting thought about the Z Score. There's no doubt that Quantitative Portfolio Managers are using algorithmic trading programs to harvest risk premia from low P/B stocks using metrics like the Z Score to minimise risk. If that's the case then the increased crowding in these trades will arbitrage away the excess returns over time.

    There's a good case for more forensic analysts to spend their time solely in the 10-20% of stocks that are failing Z-Score / M-Score type tests to figure out where the 'Type II' errors are. Its a more difficult task, but the rewards could be extremely handsome for those that get them right.

    I remember you wrote about BAE in the summer - still holding?
    http://www.ukvalueinvestor.com/2011/08/bae-systems-its-time-to-get-defensive.html/

    Blog: Follow @edcroft on Twitter
    | Link | Share | 1 reply
    MadDutch 8th Dec '11 5 of 7
    1

    May I suggest that this theme, stocks for dividend hunters, would be much more valuable if dividend cover was included; I think that a dividend % yield is worthless without knowledge of its cover.

    Take one stock mentioned above, Royal & Sun Alliance Insurance. I would not touch it with a barge pole. The dividend cover is a dangerous 1.1 times.

    I do not understand why the CEO Andy Haste was upbeat in his comments when he discussed his company’s confidence about its outlook. You mentioned this above and especially regarding the 7% dividend increase. The skinny cover tells me his company is in danger of its divi exceeding its earnings, and therefore RSA is in danger of a dividend cut.

    I hope someone can show me I am mistaken; if not, my credence of Mr Haste's future comments will be negative.

    I will be resuming my ideas thread next week, the current draft is about my preference for First Group despite the larger DY of RSA.

    MadDutch

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    UK Value Investor 8th Dec '11 6 of 7
    1

    oops.  please delete this comment.

    Newsletter: UK Value Investor
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    UK Value Investor 8th Dec '11 7 of 7
    1

    In reply to Edward Croft, post #4

    I'm not sure the excess returns will ever go away as ultimately valuations are driven by the amount of money flowing into and out of equities, regardless of what smart fund managers do. AFAIK retail investors drive the big flows and they are always driven by the recent trend up or down.

    BAE? I expect to be holding that for quite a while; years rather than months. You never know when Mr Market might drop a gift into your hand by pushing the price up, but I don't see that happening until all this debt crisis stuff fades into history.

    Newsletter: UK Value Investor
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About Ben Hobson

Ben Hobson

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