Improving market conditions through much of 2013 were obviously welcomed by many investors, but it wasn’t all good news. With share prices rising ahead of dividend growth, the yields on many stocks were pushed lower. That reduced the pool of investing options on some of the most demanding income strategies tracked by Stockopedia. Nowhere was it more noticeable than on the popular Quality Income screen. This year however, a slight softening in prices has re-opened the taps for good quality stocks offering forecast yields of more than 4%. For subscribers looking for income ideas now - perhaps with the new year’s ISA allocation in mind - this might be a good place to start.
At its heart, the Quality Income screen is all about high yield. But companies that qualify must also meet some fairly tough fundamental checks. In part this is because very high yields can be a forewarning of trouble ahead. When the market senses that a company’s dividend might be cut, the share price can fall and send the yield soaring. Unsuspecting investors attracted by the yield but not spotting the problem can end up falling into the dreaded dividend trap. Just look at RSA Insurance (LON:RSA) - back in late 2012 it boasted one of the best yields in the FTSE at 8.5%. But a few months later the dividend was cut by a third and its share price plummeted as a result.
Research by Societe Generale, which runs its own quality income index, has found that the very highest yields often don’t materialise. As a result it is worth exploring a stock’s financial robustness to ensure that its seductive yield isn’t simply a mirage. With the Quality Income screen, not only are exceptionally high yields (more than 15%) stripped out, but quality control is placed in the hands of two powerful checklists. The Piotroski F-Score of improving financial health scores every stock against a nine-point checklist. Meanwhile, the Altman Z-Score of bankruptcy risk combines five balance sheet checks to estimate the likelihood of financial distress.
Yields under pressure
Since the start of 2012 a regularly rebalanced portfolio of shares based on high quality and high yield has outperformed the FTSE 100 by 32%. But in 2013 the strategy’s performance stuck close to the main index and actually underperformed it later in…
