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Thursday, 25th April 2024 |
| Personal investment: Equity investing for income with growth |
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| High yield equity investing in blue-chip stocks will outperform other types of investment, and moreover will do so with very little input required from the investor writes Stephen Elliott. |
History shows that the stock market is the best place to grow your money over the long-term and there is no reason to suppose that this will change. Recent trends in the U.S show an increase in the number of companies now offering or increasing dividend pay-outs. This change spurred by dividend tax relief incentives has even caught on in the tech sector with companies introducing dividends payments for the first time.
Here in Ireland, current yields on a typical 7-day notice account return a nominal 0.5 per cent and a 90-day deposit just 1 per cent per annum. With corporate bonds there’s a risk of the companies defaulting, so you really need a spread of holdings and this probably means investing in a fund. Funds will incur charges and this tends to erode your potential income return. Opting for gilts may mean that you are stuck with a fixed long-term yield. Ten or twenty years from now, that income may not be worth much in real terms. Investing in tracker funds is another alternative. The FTSE All Share index currently yields just 3 per cent and, if you take a typical index tracker’s charges of 0.5 per cent away from this, you will not be left with much in terms of income.
If you want an investment with long-term income, one that will grow with inflation and economic growth, then you need to invest directly in shares. A suggestion for a long-term income portfolio is to focus your thoughts entirely on the income that the shares, and the overall portfolio generate. Cash is an important target to beat over the long term, for which high yield portfolios are designed. To justify investment in equities, they should deliver a handsome premium over cash through long periods in return for their higher risks.
One proponent of this successful strategy, Michael B. O’Higgins, ranked in the top one per cent of all money managers in the United States, runs O’Higgins Asset Management, Inc. in Miami, Florida. Michael O’Higgins’ popular book, Beating the Dow, clearly demonstrates that, on a total return basis, high yielding stocks beat the American market as a whole. One of O’Higgins’ systems simply selects the ten highest-yielding Dow stocks. At the end of each year he repeats the whole exercise again, selling those companies that no longer measure up and replacing them with new high-yielders.
The dividend yield is an important investment tool. There is very strong evidence to support the argument that high-yield portfolios outperform the market as a whole:
O’Higgins’ statistics show that, by following this system over a period of 18 years from 1973 to 1991, an investor would have enjoyed an average annual gain of 16.61 per cent compared with only 10.43 per cent on the Dow. The ten stock portfolio outperformed the Dow 13 times out of 19. After adding dividends received, but with no charge for commissions, the cumulative gain before tax was more than 1750 per cent against only 560 per cent on the Dow.
In the UK too, the 1994 BZW Equity-Gilt Study made it clear that over the previous 75 years dividends have accounted for about 42 per cent of the nominal total return on equities. Because UK companies do not cut dividends lightly, they are also a much firmer element of total return than share price growth based on potentially volatile earnings.
The arguments for buying the shares of high-yielding companies are compelling. In a climate of low interest rates, they perform well as investors become more income-conscious. However, this can easily change and it is inappropriate to buy shares just because they appear to have a high yield.
Investors creating a high-yield portfolio should avoid companies with dividends that are poorly covered, or for other reasons seem likely to be reduced.
To help assess the risk of a dividend cut a number of important factors are highlighted and should be considered:
Dividend cover - A dividend that is poorly covered is much more likely to be cut. A well-covered dividend is likely to be maintained or increased.
Cash flow per share - Earning Per Share provides cover for the dividend in terms of profits, but cash flow per share is a stronger test of future dividend-paying capacity.
Gearing or net cash - Companies with very high borrowings may have difficulty in paying dividends, even if they make substantial profits. Larger creditors can press for repayment and balance sheets may need to be repaired before dividends can be freely paid.
High yield equity investing in blue-chip stocks will outperform other types of investment, and moreover will do so with very little input required from the investor.
Shares to consider include AIB, Bank of Ireland and IL&P offering excellent yields, low price earnings ratios relative to their International peers, and strong balance sheets. |
Stephen Elliott is managing director of FEXCO Stockbroking Limited.
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| Article appeared in the July 2004 issue.
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