How to hunt for the best dividend shares on AIM this ISA season

Tuesday, Mar 28 2017 by
How to hunt for the best dividend shares on AIM this ISA season

The value of the Alternative Investment Market has risen by 30% over the past 12 months. That sort of stellar performance is likely to appeal to investors looking for a home for ISA funds this year. But while AIM has numerous attractions, it’s still a potentially risky source of investments. One way of overcoming that is to focus on the market’s better quality dividend paying shares.

Neil Woodford, the popular fund manager, recently wrote that there’s no other piece of information like the dividend that could more accurately reflect what a business really thinks about its current state of health.

For Woodford, the “walk of shame” of cutting dividends is enough to deter most executives from doing so wherever possible. Moreover, those that ratchet up their payouts do so knowing that they’re creating a bigger burden for themselves in the future. So they need to be confident that dividend growth is sustainable.

The appeal of AIM income stocks

AIM was designed to be a market for smaller, growth-oriented stocks. When successful, that can translate into spectacular capital gains for shareholders. But as a consequence, many of these companies are more likely to raise money from investors than distribute spare cash back to them.

But it’s also true that some AIM companies have established themselves as attractive income stocks. When you put that in the context of the market’s tax incentives, there are compelling reasons to take a closer look.

For a start, capital gains and dividends are sheltered from tax inside a wrapper like an ISA (subject to individual circumstances). Plus, there’s no stamp duty payable on most AIM shares, and the majority come with inheritance tax advantages, too.

Around 230 of the 970 companies on AIM pay some sort of dividend. Roughly 110 of them are forecast to yield more than the 2.3% rate of inflation in the next financial year. So how do you begin slicing through these stocks to find some of AIM’s better quality high yielders?

Screening rules for high yield small caps

Income investors tend fall into two camps - those chasing high yield and those chasing long-term dividend growth. But it’s useful to see both of these features in building a picture of an AIM dividend stock. So in filtering the market - using this screen - I’ve looked for a dividend growth streak of at least one year. One year is…

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As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested. ?>

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28 Comments on this Article show/hide all

Stephen Bland 1st Apr '17 9 of 28

GSK gearing is genuinely astronomic. I know cos I did the math from their latest accounts to 31/12/16, when reviewing this share for my own publication at the time the accounts were released. I don't rely on database figures for this purpose, prefer to get my hands dirty.

That's why I was surprised about readers unjustifiably picking on poor old BP and Shell as debt junkies when they are actually conservative in this regard.

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herbie47 1st Apr '17 10 of 28

Well BP (LON:BP.) has made a loss the last 2 years so I guess it depends how you measure it. BP (LON:BP.) debt is about £28bn at last years results, this on a mkt cap of £90bn. I suspect the debt will rise again this year and cash will fall unless oil prices rise. It has an Altman Z1 score of 1.8 which is low. I was considering Unilever (LON:ULVR) but according to that table it has more gearing than BP (LON:BP.) but at least it is making a profit which more than covers the dividend.

I hold BP (LON:BP.) and Shell in my long term income fund but it is a concern the dividend maybe cut.

I have added IG Group (LON:IGG) recently to my portfolio.

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crazycoops 1st Apr '17 11 of 28

At what level does gearing begin to concern you for a FT100 company, Stephen?

Blog: Share Knowledge
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Stephen Bland 3rd Apr '17 12 of 28

As I said above, my ideal level of gearing is zero because all debt stinks in my opinion. But we don't live in an ideal corporate world. I just can't build an HYP of zero or very low geared shares from the FTSE100.

The problem with having a fixed level of modest gearing above which I would not select an HYP share is that this rules out far too many otherwise attractive big caps on good yields. So like it or not, I am sometimes compelled to accept quite high gearing in order to achieve the crucial diversification that is absolutely fundamental to my strategy. And diversification frequently trumps gearing in the HYP approach.

Take consumer products like tobacco for example. These days there are only two FTSE100 candidates, IMB and BATS. These both suffer from what is uncomfortably high gearing. But in the past I have always desired a tobacco in my HYPs because they have been terrific dividend growth stocks over very long periods and additionally on what, in the past, were often high start yields too. I've included one or the other, and sometimes a half share in both, in every HYP I've built and that's quite a few since I launched the strategy many years ago now.

So that leaves me with a dilemma, either reject them on gearing grounds or suck it up because they are otherwise very attractive shares for HYPs. I sucked.

Similar arguments apply to utilities, which just about always have buttock clenching gearing levels, and many other shares.

What it comes down to then for me is that I consider each potential new selection, or reviewed status of a past selection, on the balance of its attractions rather than having a mechanical gearing cut-off level. I have many times rejected a share, or moved an existing selection to Hold from Buy, because I felt its gearing was excessive. On the other hand I've chosen shares, or continued to advocate past selections as Buys, despite high gearing.

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crazycoops 3rd Apr '17 13 of 28

Thanks for the detailed reply Stephen. In a nutshell, I want diversification but the debt levels and earing among the FT100 shares mean that I am more comfortable looking at smaller (but not small) companies and ETFs to achieve the diversification in my own HYP.

Thanks again

Blog: Share Knowledge
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lightningtiger 3rd Apr '17 14 of 28

This thread is meant to be discussing AIM shares which rules out the big caps which carry a lot less risk as Stephen states, but have nothing to do with the smaller AIM shares at all. At this rate we may as well include ELTA investment trust as well!

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Stephen Bland 3rd Apr '17 15 of 28

Threads do sometimes wander as you'll know.

In any case, I feel it was right on-topic to point out the risks, unacceptable for most income investors I'd guess for whom relatively low risk is crucial, of AIMs for an income portfolio and suggest better alternatives as I saw them. People then replied to me and so it progressed.

If someone chooses to write about a particular investment approach on a public forum there shouldn't be any complaints about polite and constructive criticism.

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lightningtiger 3rd Apr '17 16 of 28

Most people will agree the AIM market has much higher risks, but with the higher risks come the greater rewards. Perhaps the fairest way to see the investments is to have a total return over a timescale which includes the dividend as "icing on the cake". One of the best examples on Aim would be JOG with about a 1600% gain over the year and about a 2% dividend payout as well. This leads itself to top slicing some profits along the way if you want to, to pay your petrol bill with.
Total return of about 1602%

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Stephen Bland 3rd Apr '17 17 of 28

Yeah, well I suspect you know really that pointing to one outstanding hindsight example is a wholly misleading way to judge a strategy. I'm sure I could find AIMs that did the opposite and went bust.

Also, top slicing capital gains is no strategy for an income investor because CGs are unreliable to put it mildly, especially if you are talking AIMs. Income investors of the type I'm addressing are not traders, they want an approach that requires little monitoring and they don't want higher risks and possible higher rewards, they want lower risks and reasonable rewards.

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simoan 3rd Apr '17 18 of 28

With regard to large caps, and the sustainability of their dividends, I don't believe the level of debt tells the whole story, although it's clearly important because cheap debt will not last forever. However, you need to take into account how they are funding the dividend. In the case of the oil majors it is clear that they are selling off assets to maintain payments and that approach can only last for so long whilst the payout is uncovered or barely covered by earnings and cashflow.

Overall, I completely agree with Stephen. AIM (or FTSE Small Cap) is not a good place for a high yield investing approach because smaller companies have much less predictable earnings and in some cases will be prone to catastrophic loss of earnings which completely wipes out the dividend payment.

All the best, Si

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Stephen Bland 3rd Apr '17 19 of 28

With regard to large caps, and the sustainability of their dividends, I don't believe the level of debt tells the whole story...

Indeed and I for one never claimed that it did. It's just one factor, though I see it as a major one, in analysing a share for income purposes. The discussion regarding oil majors' debt was initiated by claims here that they had excessive debt when in fact the exact opposite is true.

Therefore, to the extent that one considers gearing to influence dividends, they score well in this regard and not poorly as was suggested.

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herbie47 3rd Apr '17 20 of 28

I agree with Stephen, a lot of these Aim companies may not be around after the next recession. SO I would be investing in large/mid caps.

Any views on Royal Mail (LON:RMG) for income? Div. 5.6% and debt does not look too high.

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lightningtiger 4th Apr '17 21 of 28

Royal Mail has a lot of competition with the likes of Amazon deliveries etc. In the same sector is SOM and worth comparing the two graphs together and also the 50 day and 200day MA's. SOM has a Rank of 97 against RMG of 79.Also in the momentum section there are all green lights for SOM but not for RMG.
On the dividend side SOM pays out a bit less at about 3% & US $ take a cut too but the potential capital gain plus a smaller dividend could well be worth it for a total return for your money.
This month I have got 8 dividend payment payments cleared coming in including some from the US market, which I think is the best for dividends, and they all worth having. Also SAN pref should pay out this Friday which will make it 9. Anybody else collecting pref shares?

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herbie47 4th Apr '17 22 of 28

In reply to post #178996

How can Somero Enterprises Inc (LON:SOM) be in the same sector? I have Somero Enterprises Inc (LON:SOM) already but I'm talking shares for income, Royal Mail (LON:RMG) are paying 5.6%. I'm not interested in US shares for income. 50MA and 200MA are for short term investing and momentum.

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ISAallowance 4th Apr '17 23 of 28

In reply to post #178826

Royal Mail (LON:RMG) (I hold a few), still accruing defined benefit pension liabilities, the scheme is only closed to new employees, not existing, I would imagine any attempt to change that would result in industrial action. On the flip side has some property in London that may be sold for a windfall, my personal opinion is the two may balance out.

Letter volumes declining, parcel volumes increasing but stiff competition, GLS expansion in Europe slowing a bit, toe-in-the-water expansion in the US last year.

Personally I think they're good value at this price, but I ditched them when they hit £5.00 last time and glad I did! (Rebought some recently).

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lightningtiger 4th Apr '17 24 of 28

Both RMG and SOM do come under industrials sector.

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Stephen Bland 5th Apr '17 25 of 28

..In the same sector is SOM and worth comparing the two graphs together and also the 50 day and 200day MA's. SOM has a Rank of 97 against RMG of 79.Also in the momentum section there are all green lights for SOM but not for RMG...

As pointed out by herbie47 there is no similarity whatsoever between RMG and SOM. RMG delivers mail, SOM manufactures laser measuring equipment. Adding to their difference, SOM is a US small cap, RMG is a UK big cap. So they are quite obviously not in the same sector and you could hardly find two more dissimilar companies.

Official sector taxonomy contains so many anomalies that it's useless, even dangerous, for investors interested in building a diversified portfolio. Portfolio diversification is especially important for income investors to reduce risk and my advice is that people desiring it make up their own minds on the nature of a business and the extent to which it varies from their other holdings.

As for the chartist view mentioned, again like herbie47, I don't think that has anything to do with income investing where people will hold shares for long periods. And I say again that income investing by attempting to harvest capital gains, in other words by trading, is a foolish way for an investor in need of income to proceed.

Why? Because gains are chancy, unreliable, unlike dividends (though these also carry risk of course) and nearly all traders lose money in the end. And that aint too clever for someone depending on income.

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lightningtiger 11th Apr '17 26 of 28

I got the Industrial sector clearly shown on the Stockopedia pages Sure they are two totally different companies, and SOM currently has a good trend line.
You say gains are chancy and unreliable and aint too clever for someone depending on income. I disagree because if a share like JD has a good trend line and only pays out less than 1% as a dividend right now the share price today has again increased I could easily top slice say 10%. there is nothing chancy about that! , and bank it as extra icing on the cake.
In this example the JD share price has increased massively over the years an a small top slice from time to time is some safe cash in the bank.

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Stephen Bland 12th Apr '17 27 of 28

I've already pointed out above that selecting one successful example with hindsight just does not demonstrate the merit of a strategy. Similarly my selecting one failed example would not demonstrate it either. It's a totally naïve way to discuss the subject. Surely you can see that?

It's well known that traders, which is what you are suggesting, overwhelmingly lose or make very little. That isn't based on pointless single examples but studies of large numbers of them. I take it that you are familiar with this fact.

If it works for you, that's fine, assuming you have tested your approach over a large number of trades and a lengthy period and are not just basing it on a few lucky hits. But that puts you into a tiny, vanishingly small minority so it's clear to me that this sort of trading most certainly cannot be utilised by investors because they just don't have that skill. Many think they do and find out later, the hard way, that they don't, confusing a bit of early luck with skill.

Consequently I stand by what I said that almost no investor can rely on making an income by harvesting capital gains for the clear reason that this is just too risky and difficult to achieve. Dividends on the other hand involve massively less risk and are therefore hugely more reliable than gains. And reliability, as far as that can be achieved with those choosing equities for income, is paramount for income investors. It trumps everything else.

That's why my advice to equity income investors is to go with a very diversified portfolio of HY big caps with equal investment in each and then do nothing unless compelled to do so. This has the added benefit of freeing investors from having to monitor their shares constantly and to "get a life" as the cliché says.

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lightningtiger 14th Apr '17 28 of 28

My strategy of top slicing works well for me,as I am sure it does for lots of other investors. Having had a quick count up 14 in the last 12 months at least 10% to over 50%, all successfully executed without any risk.
. I am also aware that most traders, including option traders lose money, with the odd one or two that have mastered how to be extremely successful. Not everybody's cup of tea.
For me the US market provides better yields with some carefully selected shares than can be found here in the UK, and I keep this part of my portfolio separate to generate a 10 to 14% yield. The "trick now" is to re invest some of this back in to the shares to provide an ever increasing income. This is where the top slicing can help do "the trick".So that's my plan and it is working well for me.
Obviously dividend re investing with big caps is to achieve a similar way to do a similar thing at much lower costs, but limited to increased payout of how much the dividend is but still has the magic of compound interest coming into play.
The AIM stocks, with their higher risk can be selected carefully to give excellent capital gains for top slicing, or left to run & build up further capital. If you have some that pay a good dividend, so much the better..Now I can concentrate on getting a few more growth shares into my portfolio.

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