The dog shares of 2012
The Dogs have earned their keep again. Money Observer's canine portfolio has once again beaten the stockmarket, cementing an impressive decade for the pedigree hounds.
Regular readers will know that we have not taken up dog racing: we are referring to the Dogs of the Footsie, our annual assembly of the least-loved shares in the FTSE 100 index, as measured by their dividend yields.
Last year's portfolio proved that outsiders can be an excellent bet: measured simply by share price, the Dogs made a marginal loss of 0.27% in the year to the end of January, a much smaller loss than the 4.6% seen in the FTSE 100.
However, when dividends are included, the Dogs really show their form with an impressive total return of 5.6%, while the FTSE 100 remains in negative territory, with a loss of 1.22%. The dogs are also well ahead over the past 10 years, growing by 7.3% in share price terms, two-and-a-half times the 2.86% growth in the index.
Meanwhile, the total return of 13.4% was more than twice the 6.5% return for the FTSE 100. That does not surprise those whose business is income investment. A growing body of research shows that dividends are a crucial part of investment returns.
Barclays Capital's Equity Gilt Study, the authoritative review of investment returns, shows how vital dividends are. In real terms, £100 invested at the end of 1945 would have grown to £277 by the end of 2011, after allowing for the eff ect of infl ation, if you had spent the dividends - reinvest them and it would be worth £4,027.
Dan Roberts, who has just launched the Fidelity Global Dividend Fund, says the same holds true in other markets. Over the past 110 years, US equities have returned an average real return of 1.9% a year from the rise in share prices alone. Add in reinvested dividends and that jumps to 6.3%.
He has also analysed the performance of what he calls dividend aristocrats – international companies that have grown their dividends every year for a decade. They achieved a total return over 10 years of more than 160%, compared with around 50% for the market as a whole.
Roberts attributes that to the fact that companies that can consistently grow their dividends tend to be cash generative and profitable, and to have healthy balance sheets. "So for income investors, focusing on sustainable dividends produces a powerful tail wind,' he says.
The Dogs strategy does not, however, require much investment skill. We are not interested in dividend growth or company prospects, merely in the level of the yield. The portfolio is made up of the 10 highest-yielding stocks in the FTSE 100, which are held for a year and then replaced with the next batch of laggards. While we exclude companies that have said they intend to cut their dividends, we don't bar firms because analysts have forecast a cut.
The logic is simple: out-of-favour companies often fall too far and, when investors reassess their fortunes, they can bounce back sharply. You can choose any date to start your own portfolio. Our sister website Interactive Investor (www.iii.co.uk), has a screening tool that lets you select high-yielding shares from the FTSE 100. It is important to buy all the shares highlighted, taking into account the caveat above, even if you do not like them – to get a bit of diversifi cation. Good performance from some – GlaxoSmithKline and National Grid were the stars of last year's portfolio – can compensate for disappointment with others, such as Aviva and RSA Insurance.
The strategy originated in the US as Dogs of the Dow. It did well in 2011, delivering a 17% total return, compared with a 1.7% loss for the Dow as a whole. Over the past decade, the diff erence has been smaller: 6.7% for the Dogs of the Dow, compared with 6.1% for the Dow as a whole.
Despite our portfolio's success, the only fund following a similar strategy - the Henderson Rowe Dogs of the FTSE – which picked the 15 companies with the highest prospective yield, has closed, following a period of underperformance. It may be that looking at historic yields, as our portfolio does, rather than forecast dividends, and making an annual change, makes a difference.
With stockmarkets sluggish, dividends are becoming an increasingly important part of total returns. If you can lock in a yield of 7.2%, the average for this year's Dogs, that secures a decent return, even if the stock market remains lacklustre.
If the Dogs can also grow their dividends - and many in the portfolio say they aim to do that - the returns could be even better. Across the market as a whole, dividends have recovered from the doldrums of 2008. Capita Registrars says dividends in 2010 reached a record of £67.8 billion and should grow by a further 11% this year, a firm foundation on which to build an income portfolio.
THE DOGS OF 2012
This year's portfolio is heavily skewed towards insurance companies, with half of the portfolio in either the general or life insurance industry. Other financial companies – Man and ICAP – take up a further two places and are joined by two utilities and a defence contractor.
MAN GROUP (EMG)
Price 121.70p Yield 11.47%
The investment manager has been suffering outflows of funds as clients have realised that even hedge fund managers are not immune from making losses when markets are turbulent, despite the extremely generous fees they receive. Analysts are concerned that outflows will continue, putting pressure on the dividend, although Man is committed to maintaining the payout for the year just ended.
It has been cutting costs and has identified further savings, which should keep profits moving ahead.
Price 108.5p Yield 8.15%
The management of the insurance group admits the market is challenging. Extreme weather and earthquakes have resulted in a rise in claims, increasing competition for business and pressure on rates.
Insurers are heavily exposed to bond markets, which could be affected by any change in interest rates. The company has so far pledged to maintain its dividend.
Price 933p Yield 6.18%
Admiral, the company behind website Confused.com as well as car insurance brands such as Elephant, Diamond and, of course, Admiral, warned last year that personal injury claims had increased and said that, if that trend continues, profits would be affected.
However, last year's dividend was Admiral's highest ever. It included a special payout of 19.7p.
Price 357p Yield 7.46%
The group's savings business in Europe has been suffering falling sales, and it lacks exposure to faster-growing markets such as Asia. But it says it is on track to meet its financial targets, its general and health insurance business is doing well, and it is focusing on core markets and cutting costs.
RESOLUTION GROUP (RSL)
Price 274.9p Yield 6.66%
Resolution was set up to acquire the assets of other life insurers and is in the process of integrating Friends Provident and Axa UK Life. It says it is on target to achieve cost savings and has released enough capital to buy back some of its own shares.
Like the other insurers, however, it is sensitive to movements in gilts and interest rates. As an aggregator, it is also under pressure to keep finding new acquisition targets, without overpaying.
STANDARD LIFE (SL.)
Price 223.5p Yield 6.21%
The Scottish insurer describes its trading as 'robust' and says it is on track to deliver the promised benefits from its transformation programme. But it admits the 'challenging' financial climate is affecting inflows from investors, while the value of its assets will be affected by equity market movements.
Income from fees is rising, as is investment into its self-invested personal pension platform. It remains committed to a progressive dividend policy.
Price 362p Yield 6.18%
ICAP, the largest interdealer money broker in the world, has been hit by reduced demand for its services because of the global economic crisis. Its results could be further affected by the imposition of a 'Tobin tax' on financial transactions, a proposal currently being debated in Europe.
However, it is realigning its business and cutting costs, and it is committed to a progressive dividend policy.
Price 1,234p Yield 6.02%
Utility companies have been stalwarts of the Dogs portfolio because of their dependable earnings and dividend streams. Even they are not immune to economic pressure, however. Competition and high prices are taking customers away, while those that remain are using less power. SSE's business could be affected by impending regulatory reviews.
But the company boasts that it is one of just six FTSE 100 companies to have increased its dividend in real terms every year since 1999, and it says maintaining real annual increases remains its top priority.
NATIONAL GRID (NG.)
Price 634p Yield 5.89%
National Grid is a transmitter and distributor of electricity in the UK, but it also has a sizeable US operation. Like SSE, it is affected by regulatory actions largely beyond its control, while its foreign operations mean it is exposed to currency fluctuations.
It is committed to dividend increases: it promises a 4 per cent rise for the year to March 2013.
BAE SYSTEMS (BA.)
Price 313p Yield 5.88%
BAe Systems, one of the world's biggest defence contractors, is at the mercy of government spending cuts – which are already happening in the UK and the US. But its management is confident the company will continue to win orders. It has also been shedding staff to reduce costs. A share buyback programme in place.
Presented by highest yielding share, data as at 1 February 2012
This article was written for our sister magazine Money Observer
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.