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!
Disclaimer
This is not financial advice. Our content is intended to be used and must be used for information and education purposes only. Please read our disclaimer and terms and conditions to understand our obligations.
23 comments
Stephen, I’m surprised that the 5 year test for the Motley Fool was disastrous, because my observations were positive, even without taken account of dividends, but after reviewing my thoughts I realise that the virtual portfolios I set up were hold and leave alone portfolios. And as you have noticed a lot of the same shares seem to like revisiting this (High Yield) area of the market. Maybe I just happened to start at the right (wrong ?) time. But i’m only using these mechanisms as a starting point for my real money selections. Although I am now changing my view to the FTSE, to fit in with the screen available, 4 of shares to choose from are the same ones.
The Dogs scheme originated in the USA using the Dow30. In the UK , basing the Dogs on the virtually extinct FT30, which was set up to be a UK version of the Dow, was an attempt to replicate it here. As I've written, the Motley Fool five year test of this which I monitored for them was disastrous.
I never liked using the FT30 for the Dogs approach and my view is that a similar mech on the FTSE100 based on annual reselection of the top five or ten HY shares and adding in my diversification filter is more likely to reduce risk and be a winner long term for people interested in following mechs though I have no proof of this. I'm not personally interested in mechs much any more though I was many years ago.
I was introduced to this concept several years ago by a company that doesn’t appear to exist any more. All of my virtual portfolio’s did well. Virtual because I found being married and having money to invest didn’t fit together. Another difference was that the criteria was applied to the constituents of the FT30 index rather than the FTSE100. It can be difficult to find out when the constituents change but it reduces ( but not eliminate) the problem of diversification. Now that I have re-started a real money portfolio and am looking to add a new share, I check to see which shares are in the current top 10 and add it, provided that it is in a sector that isn’t currently represented. These selection will be reviewed 12 months after being added, but it won’t make sense replacing any of them unless an alternative is yielding at least 2.5% more (1.5% buying costs and 1% selling costs)
...The stand out from your list is M&S. Most would be classifying M&S as a Value Trap and would filter it, as not eligible even for Dogs of the Dow
As I said, the Dogs is purely mech so you apply no personal opinion and thus MKS would remain as a selection for someone following it.
It's not a Dogs any more if you start applying personal views to the selections and there are numerous ways you could that. I'm not saying that's wrong, there's no right or wrong here, just that the commonly understood meaning of a Dogs approach is a mech strategy so that's what I've done.
I devised what I've written for anyone interested but don't follow it myself. I just continued the discussion from other people in the thread, in particular a reader seeking to bring the old thread up to date, and chucked in my 2¢ worth. However, if anyone does want to follow it I felt that the single filter of yield, which is the original Dogs approach, would invite excessive risk by often choosing more than one company from the same beaten up sector.
My view is that a second filter of diversification will ameliorate that sector risk. That don't mean it will perform better, it just means the risk is probably lower.
letap73 is the only one who reads the posts my friend.....................I'm sure we all read them but only respond when we have something to say !
Please keep up the interesting postings.
Thanks for the comments, now I know that at least one person has read it!
The whole point of the dogs approach is that the companies are very likely to be experiencing a bad patch, that's why they are so low rated. It's based on the idea that this low rating has been overdone so the shares may show price recovery in the holding year, plus deliver some dividends. Some will, some won't, but on balance the hope is that enough will to make the scheme work with gains over many years.
It is not a part of this strategy to examine the companies and revise the selections by inputting your own feelings, because it is a mech approach, meaning it is designed expressly to overcome any personal views. Once you start fiddling with the selections, it's no longer a mech. I am not saying that's wrong, just that we are talking mechs here.
As for further filters, there are many additional tests one could apply but it is meant to be as simple as possible. The original scheme was just one filter, yield, I added diversification to lower risk, based on lengthy experience with schemes like this and HY and value investing, but that's it for my version. People have devised all sorts of variations on the dogs concept over the years, but this is my particular contribution to the large number of such approaches out there.
Stephen, Appreciate the posts, I read it. The stand out from your list is M&S. Most would be classifying M&S as a Value Trap and would filter it, as not eligible even for Dogs of the Dow.
Here is the latest HY5, my version of the mech strategy based on just the two filters I mention above of highest yield and compulsory diversification, drawn from Stockopedia's yields in the FTSE100:
Persimmon 9.19%
Centrica 8.59%
Marks & Spencer 7.02%
Micro Focus Int 6.88%
Imperial Brands 6.81%
Haven't done this for a while and there are three changes from the last run. Out go Taylor Wimpey, Direct Line and Lloyds, replaced by Persimmon, Micro Focus and Imperial Brands. No investigation of these companies has been applied in choosing these shares, nor any personal opinion, they are purely the mech result of the two filters.
It is worthy of note that none of the original five shares from the first mention of my version of this strategy seven months ago in September 2017 recur in this latest list.
Just to recap, the strategy is not really about income as some think, rather, its aim is long term capital growth from a combination of share price gains and reinvested dividends.
As no interest seems to have been expressed here in this, I'll probably refrain from any further posting of the idea.
You should continue to post. As someone who is relatively new to investing the obvious strategy would be to look at high dividend yields - so it would be interesting to see how this strategy pans out over the long term.
A cursory glance at the five above - without any research - would suggest that three of the five, Centrica, M&S and Micro Focus are not doing very well, the share price is dropping and the dividend maybe cut. Would it be worth putting an additional dividend cover filter to your screen?
Here is the latest HY5, my version of the strategy based on just the two filters I mention above of highest yield and compulsory diversification, drawn from Stockopedia's rolling 12m yields in the FTSE100:
Centrica 8.49%
Taylor Wimpey 7.44%
Direct Line 7.12%
Lloyds 6.87%
Marks & Spencer 6.30%
Haven't done this for a while and there are two changes from the last run. Out go SSE and Vodafone, replaced by Centrica and M&S. No investigation of these companies has been applied in choosing these shares, nor any personal opinion, they are purely the mech result of the two filters.
It's a month after my last HY-Five share selections in my version of this, which I'll call the The Hounds of the Footsie mech strategy.
It has two filters, high yield and separate sectors, the second filter being my personal addition. Just for a larf, I show the latest HY-Five selections and their yields. The results are drawn from Stockopedia's rolling 12 month yields.
Direct Line 7.65%
Taylor Wimpey 7.41%
SSE 6.99%
Lloyds 6.47%
Vodafone 6.21%
The sole change from a month ago is that BP has been replaced by Vodafone. That's what I'd expect, little or no change in the HY-Five over the short term.
As before I am not following this scheme personally and make no claims for it. So if it's shit then that's nothing to do with me. If it's a star, then naturally that's everything to do with me.
The Hounds mech scheme, like its original version in O'Higgins Dogs of the Dow, is very long term and so cannot fairly be judged over much less than say ten years. There will be good years and there will be bum years but the idea is that the good ones more than make up for the poor ones so as to deliver a great return in time. That's the theory - the practice may differ.
To recap, you buy the five with equal amounts each, wait a year and repeat, adding in the accumulated dividends and any other cash receipts such as cash returns, lapsed rights, a bid etc. always ensuring that equal amounts are invested in the new HY-Five. Any shares that appear again are reduced or increased accordingly so as to match the new equal amount invested per share in the new list.
Apart from the two mechanical filters, no personal preference is expressed for any selections, you just go with the mech and ignore any views that you may have, pos or neg.
One final point, although this is classifed as income investing and I'm just following the existing thread, I think that this scheme and all the other related ones are much more accurately described as capital gain strategies. That's because their aim is for a good capital return over time and certainly not to draw a regular income. The confusion arises because these methods use yield as a selection criterion but it is just that, a selection filter and definitely not the purpose of these mech investment styles.
Ben,
You mention with regard to Astrazeneca: "although 2011 will probably be a year to forget for both the company and its investors." I take it you meant 2017? However, if you did mean 2011, what is the current significance?
Unapologetically a pedant, and do feel free to highlight all my typos, Clive.
The original post is from 7th of December, 2011.
Apologies, where I wrote Taylor Woodrow above it should of course have read Taylor Wimpey.
Okay, here are the five current highest yielders in the FTSE100 ranked in descending order based on rolling one year yields from Stockopedia:
Taylor Woodrow 7.37%
Direct Line 7.12%
Lloyds 6.92%
BP 6.76%
Barratt Devs 6.68%
I have not analysed these companies and have not applied any selection filters other than yield so it's purely a Dogs mech in accordance with the method without any personal views on the shares. I am not advocating the strategy, just featured it out of interest and in response to the above message.
Personally, if following this, which I'm not, I'd apply just one more filter - diversification to lower the risk. In the above list there are two housebuilders and seeking the next on the list in a new sector replaces Barratt to give the following:
Taylor Woodrow
Direct Line
Lloyds
BP
SSE 6.66%
The idea is to hold for a year then sell and reinvest together with accumulated dividends into the new five highest yielders, equally in each, and repeat annually. If the same share(s) occur in the new selections then keep that portion making equal investment and sell the balance to reinvest in the others.
Good luck to anyone adopting this but don't blame me if it's poor. On the other hand if it works well, I'll take the credit. ;~)
Great article on what is a popular strategy , so could we please bring this one bang up to date Ed ? Many thanks , Andrew
oops. please delete this comment.
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
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.
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 Coke...
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%.
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/
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.