10 stocks to help or hurt your pension
As you watch television or read the newspapers, the dramas unfolding in the world's highest-profile companies can seem very distant.
Over the summer we all watched as BP oil spewed into the Gulf of Mexico, but it was only when the company bowed to pressure to suspend its dividend payments to help it foot the clean-up bill, and during the furore that followed, that many savers in the UK started to make the connection between the oil giant's fortunes and the performance of their pension funds.
Few people are aware of exactly where their pension contributions are invested each month, but if you have a pension, the chances are you're invested in BP. In fact, it's the biggest holding in most people's retirement pots, with £1 in every £7 of UK pension funds.
But BP isn't the only big pension stock you need to be aware of. We explain what you need to know about 10 stocks you might not even realise you hold.
It's no secret that the terrible events at the Deepwater Horizon drilling rig have taken a massive toll on BP.
The costs of the clean-up and capping the well have been conservatively estimated to be around $35 billion and were responsible for the firm's $17 billion loss in the second quarter of 2010.
However, this could be just the beginning. Peter Day, an analyst at Killik & Co, warns: "Even after all this, you have litigation threats from the US. The risks are huge."
The Deepwater Horizon disaster was a once-in-a-lifetime event. However, Nick Raynor, an investment analyst at The Share Centre, points out: "It goes to show there are big risks in the sector.
"There are environmental risks and political risks, as well as the basic fact that when the company drills for oil it can spend millions and find nothing."
Pension funds invest heavily in pharmaceutical stocks, and GlaxoSmithKline is highly favoured, partly because of its large, reliable dividends.
At the moment, it's paying 5.2%, but Henry Dixon, an analyst at Charles Stanley, says: "The overriding focus is to grow the dividend, and I believe that it can happen."
Another attraction is the fact that the company is not carrying too much debt, and the current management is focusing on cost-cutting, which should ease its debt position still further.
The sector has its share of headwinds. Pharmaceuticals suffer from increasing price regulation, and the big companies are facing competition from generic drugs, which are far cheaper than their branded offerings.
They're also facing a shortage of new drugs in the pipeline, which means they don't have a steady stream of medicines coming to the market, so new products are either going to dry up or will have to be bought in.
However, unlike its rivals, Glaxo has an unusually strong pipeline. It also has a secret weapon, in that 20% of the business is in household products. Dixon says: "You shouldn't underestimate the growth that this division can achieve."
ROYAL DUTCH SHELL
The other massive oil and gas company in most portfolios is Shell. It appeals for a number of reasons, among the biggest being a dividend of 6%, which is very attractive to anyone seeking income.
It shares the same sector-specific risks as BP, but has a stronger balance sheet. The fact it hasn't suffered a Deepwater Horizon-type incident makes it a more attractive option to many.
In fact, Day points out that Shell could benefit from BP's woes. He says: "The situation at BP will push the oil price up. Tighter regulations in future will mean less oil is drilled, so the price will increase, benefiting the broader sector."
This telecom giant is a common component of many pension fund portfolios, despite a decade of struggle.
In many instances, it's in the mix by dint of its sheer size and dividend history, although growth has been relatively disappointing after some poor purchases during the dotcom bubble years.
The future, however, looks brighter; and the stock is a real favourite for Dixon. The yield is just over 5%, and he likes the dividend promises. "It has put in place a target to grow the dividend by 10% for each of the next three years," he says.
Results in July suggested the company has turned the corner on growth, with the first signs of organic revenue growth already apparent.
This is the only UK bank still favoured by many pension funds due to its relative strength and the fact that it defied broader trends in order to pay a dividend this year. The yield is currently 3.5% and is expected to grow.
Raynor says: "It's one of the more well-managed, liquid banks, especially after a huge rights issue."
It may seem counter-intuitive to talk of the company's strength, given that the share price fell from around £8 to closer to £3.20 during the financial crisis, but this was a relatively good performance compared with other UK banks.
Some 25% of the company is based in emerging markets, which have been performing particularly well. At the moment, analysts like the fact that things may not be as gloomy as first predicted.
Dixon highlights the fact that HSBC has been pleasantly surprised by the number of loans in the US that are being repaid and has revised its accounts accordingly.
However, there remain significant risks. Raynor points out that a further slowdown would leave the company highly exposed to its "huge outstanding loans".
"It has a big exposure to the US mortgage book," he says. "It took a gamble by buying mortgage books in the US at the peak of the crisis. Time will tell if the risk pays off."
AstraZeneca suffers from the same headwinds as the rest of the pharmaceutical sector, and is more exposed than Glaxo to the shortage of new drugs in the pipeline.
Dixon says: "It's the pharmaceutical company everyone loves to hate. However, it's tremendously cash-generative, and has signalled a drop in dividend cover (which measures the number of times the company's profits could cover its dividend), so dividend earnings should improve further."
This isn't such a high-yielding stock, but it's well-liked. Day says: "It has a fantastic brand in the UK – it makes up £1 of every £8 spent with UK retailers – and it's not too reliant on the economy, because people always need groceries. It's also a big international growth story – 60% of its floor space is outside the UK."
The risk is that so much success is priced into the shares that any minor surprise on the downside could damage valuations.
However, Day believes this risk is overstated and that the stock is well-priced. As Raynor says, "Tesco will soon take over the world".
BRITISH AMERICAN TOBACCO
Traditionally a strong defensive play, with good dividends, British American Tobacco is currently yielding 4%.
However, Raynor says: "We're seeing a slowdown in the cigarette market. The sector is showing weaker sales, and the inherent risk is that people want to live longer and healthier lives, so may not choose to smoke. Africa is one of the only regions left for major expansion."
Raynor says BAT is likely to have a place in pension portfolios for the foreseeable future, as pension funds are looking for dividends and stability, but that the stock and the sector may stagnate in the longer term.
The owner of the likes of Persil, Dove and PG Tips is a good defensive stock that can weather tough times, largely because it sells well-loved brands.
Day says: "It has products people know and love and have been buying for decades. It's a very high-quality business." Raynor adds that it has been trimming its portfolio and streamlining the business.
The real risk to the stock is that it is expensive. In addition, Raynor points out: "If tastes change or disposable incomes fall, people will move to cheaper alternatives."
This recently raised more money to shore up the balance sheet, and although it has a lot of debt, it is covered by bonds. The company has a 7.5% dividend yield and a progressive dividend policy.
Day says: "It's a well-managed business and a defensive one for difficult times." Raynor adds: "The only way it could run into problems is if it over-exerts itself."
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%.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
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.
A way a company can raise capital by creating new shares and invite existing shareholders in the company to buy these additional shares in proportion to their existing holding to avoid a dilution of value, which means keeping a proportionate ownership in the expanded company, so that (for example) a 10% stake before the rights issue remains a 10% stake after it. As an added incentive, the new shares are usually offered below the market price of the existing shares, which are normally a tradeable security (a type of short-dated warrant) and this allows shareholders who do not wish to purchase new shares to sell the rights to someone who does.