For those of us that want more bang for our buck in the coming year, a self-select ISA focused on stocks that deliver sparkling dividends could be the ideal solution. Shareholder pay-outs from London listed blue chips hit record levels last year and the signs are that dividend growth will continue again in 2012. The trouble of course is that even the most stoic investors in some of the sturdiest FTSE 100 stocks can never be certain of a sure thing. With economic malaise still weighing heavily, those of us with an eye on dividends need to take a more methodical approach to placing our bets.
According to Capita Registrars, which monitors dividend payments by UK listed firms, dividends bounced back to a new record in 2011 and despite economic uncertainty are forecast to rise by 10.6% to £75.0bn in 2012. That means that this year, the prospective gross dividend yield for the FTSE 100 is 4.5%. But can you match or even beat that? And, if you can, how can you heighten your protection from the risk of stocks that may unexpectedly hit hard times and cut their yields to shareholders?
Dogs of the FTSE
Screening the market for the best yields is nothing new when it comes to investment strategies. In the early 1990s Michael O’Higgins and John Downes popularised what is known as “Dogs of the Dow” in their book Beating the Dow. Their technique dumped traditional valuation metrics and focused simply on digging out stalwart income generators and spreading the risk with a 10-strong portfolio of the best yielding shares. At Stockopedia, we have produced a UK version of this approach, which has returned 11.81% over the last three months compared to 3.62% for the FTSE 100. But some might say that this isn’t enough…
With a straightforward yield screen, investors can quickly spot the best dividend payers but that gives no indication of whether a company might be about to reduce payments or shelve them altogether. Indeed, a high yield can be an indicator that the market thinks a dividend may soon be cut.. To counter this problem, one metric to keep an eye on is the dividend cover – or the cushion each company has to pay those dividends without compromising earnings. Another strong filter, particularly given the dramatic and sometimes unexpected effects of tough economic conditions, is to put each company through an SAS-grade accountancy obstacle course known as the Piotroski F-Score.
Financial health check
Our Highest FTSE 100 Dividend Yields screen takes the simplicity of grading companies with the highest forward yields but asks some demanding additional questions. US accounting professor Joseph Piotroski is famous for his nine-point accounting test, which is typically seen in value investing situations. There, the screen is used to identify stocks with strong fundamentals that appear to be mispriced by the market on a price to book basis. On its own, the screen is up a very commendable 18.3% over the last three months. But could the same thinking be applied to income investing? With this in mind, we have taken our high yielders screen and spiced it up with the requirement that each company must be achieving an F-Score of at least 7.
That scrutiny whittles down the top 100 UK listed stocks to 46. You can see the full list here but we have plucked a few names from the bunch that may be worth further research. It should go without saying that analysis of fundamentals is a great starting point but further due diligence on each company and its markets is essential, and none more so that with telecoms giant Vodafone (LON:VOD), which currently offers the best forward yield to investors amongst the FTSE 100, with a huge 8.29% forecast yield. In 2010, Vodafone launched a revised corporate strategy with a focus on targeting growth markets and said it was aiming to produce 7% dividend growth in each of the following three years. Investors will find out how those strategies are going when the company reports its results in May. Meanwhile, squeezed margins and a lower return on assets in 2011 mean that the company has an F-Score of 7 out of 9. One note of caution that’s rather surprising about Vodafone is that it is showing an Altman Z-score in the danger zone – that’s rather hard to believe frankly given the company’s profile, but the Altman test does produce false positives from time to time.
The best yielding stock on the list that manages a full F-Score of 9 is accountancy software group, Sage (LON:SGE). With a forward yield of 3.53%, what Sage concedes against its higher dividend paying peers it takes back with what looks to be top notch financial health. With a client list that is predominantly SMEs, the company is particularly exposed to the macro economic climate. However, Sage throws off a lot of cash and while it appears keen to spend at least some of that on acquisitions, the company has stressed that new purchases are not vital to its strategy. Its decision last year to rebase its dividend saw the 2011 pay-out rise by 25% to 9.75p.
Royal Dutch Shell (LON:RDSA) is the best performing oil & gas group according to this list, with peers BP (LON:BP.), BG (LON:BG.) and Tullow Oil (LON:TLW) also appearing. Shell’s robust F-Score of 8 and forward yield of 5.17% come as the company recently announced plans to invest $30bn into projects during 2012 in order to grow further. The company paid out $10.5bn in dividends last year and said it plans to grow that figure this year.
Among the country’s blue chip food retailers, J Sainsbury (LON:SBRY) steals a march on Tesco (LON:TSCO), with a forward yield of 5.25% versus 4.75% and both companies achieving an F-Score of 8. While Tesco saw sales dip over the critical 2011 Christmas trading period, Sainsbury’s enjoyed a modest rise. That has simply served to intensify scrutiny of the two companies in what remains a hugely competitive environment made worse by the economic conditions. It is worth noting that Tesco has a proud record of 27 consecutive years of dividend increases – and it won’t want to give that up too easily. All eyes will now be on the two companies’ results when they report in the coming weeks.
Do your homework
As ever, no screen is a substitute for independent judgement but it can be a useful starting point for further research. For dividend hunters tempted to use tax-free ISA allowances to invest in super high yielding stocks, care is needed. While the consensus among market analysts is that UK PLCs are sitting on the strongest balance sheets for over a decade, there are no safety nets should companies change their minds – and past performance is not necessarily a guide to the future. However, combining a list of the current best blue chip yields with some hard and fast accounting metrics courtesy of Professor Piotroski could be one way of getting a better fix on the best home for your money. It will be interesting to see if this approach can beat a straightforward Dogs of the FTSE screen over the next 12 months.