In last week’s article, I examined the evidence for income investing. I concluded that a pure income strategy might be a sub-optimal way to invest. However, creating an earnings-based value strategy and then choosing to invest in the subset of those stocks that have a high dividend yield will likely generate high performance and deliver an above-average yield. Based on these principles, I can construct a suitable income stock screen.
The Screen
Here are the criteria:
Market Cap > £150m.
Although I don’t want to be too restrictive at this stage, it makes sense to exclude the smallest companies. There was some evidence that income investing works best in the largest companies.
TTM Earnings Yield, Rank in Market > 60%
In my previous articles on earnings-based value strategies, I described how this appears to be the best valuation metric to use. A value above 60% rank in the market ensures I am capturing only cheaply-rated stocks where the evidence points to long-term outperformance.
TTM Dividend Yield, Rank in Market > 60%
This is an income strategy, after all, so I want to find the highest-yielding stocks. Again the evidence points to the top two quintiles being the sweet spot for income.
1-Year Rolling Dividend Yield, Rank in Market > 60%
I include this extra check to try to ensure that I do not include stocks that have cancelled their dividend or are likely to significantly cut the size of the payout in the near future. This relies on brokers’ forecasts which are not always accurate, particularly during times of economic uncertainty. However, some guidance on this is better than nothing.
There is a risk that this requirement excludes companies that will continue to pay dividends but lack broker forecasts. I conducted a quick analysis by unchecking this criterion in the stock screen like this:
This exercise showed that most of these companies are funds, often income funds. So it makes sense to exclude these since I don’t want to pay fees for someone else to build the type of portfolio I am building myself directly.
Net Gearing, including Pension < 50%
Net Gearing is the ratio of Total Debt to Shareholders’ Equity, which is total assets minus total liabilities. We don’t want excessively geared companies since these are more likely to have to prioritise debt principal or interest payments than dividends in a…
