Friday 28 December 2012

The RIT High Yield Portfolio (HYP) – Adding VOD plus the New Contenders

The full detail on what a High Yield Portfolio (HYP) is, why I decided to build one and full detail on my initial selection can be found in my original post on the topic.  This post builds on that original HYP post and so is important reading for any newcomers to Retirement Investing Today.

Wealth Warning: As I said in the original post I don’t know if long term this HYP strategy will work.  There is every chance that a simple diversified portfolio of lowest expense index trackers that are invested tax effectively will in the long term outperform this strategy.  Only time will tell.

In November 2011 I added my first 3 HYP companies.  These were AstraZeneca (LSE ticker: AZN), Sainsbury’s (LSE ticker: SBRY) and SSE (LSE ticker: SSE).  I’m writing this post as late last week I added my 4th company, Vodafone (LSE ticker: VOD), for which I had to pay £1.552 per share.  This purchase was funded by moving 0.8% of my Low Charge Investment Portfolio assets from cash.  It takes the HYP portion of my Portfolio to 3.2% of total assets.

It’s been over a year between purchases.  The HYP is counted as part of the UK Equities allocation within my non-emotional mechanical investment strategy.  With the majority of that currently being FTSE All Share Trackers, which have risen nicely over that period, I have been given no opportunity to buy with either new money or rebalancing.

Reviewing the High Yield Portfolio

In my original post I stated that “The first priority is to amass 15-20 shares (minimise company risk), from different industries (minimise sector risk), from the FTSE 100 (minimise stability risk) that you believe will spin off dividends that rise at or above the rate of inflation.”  The purchase of Vodafone means I am still a long way from a mature HYP with a need to purchase shares in a further 11 to 16 companies.  All 4 companies to date are from different industries and are from the FTSE100.  Year on year all have increased their dividends at or above the rate of inflation – SBRY by 6.6%, AZN by 9.1% (once converted from $’s to £’s), SSE by 6.8% and VOD by 7.0%.

With the first priority met my second priority was “to maximise the capital growth ... of the portfolio” which will “ideally be an outperformance when compared to the UK market.”  To account for purchases at different times, which I need to do if I am to benchmark myself against the FTSE100, I unitise my HYP.  Since purchase my HYP units have risen by 12.3% and calendar year to date they are up 8.1%.  This compares favourably against the FTSE100 which with a Price of 5,951 at the time of writing is up 12.0% and 6.8% respectively. 

All have provided a dividend yield above that of the FTSE100’s current 3.69%.


Buying Vodafone plus the New Contenders

In my original post I detailed the Acceptance Criteria for a share to be selected for my HYP and mused that the next share purchase could be Vodafone.  Let’s review my current 4 shares against these Criteria plus add 3 new possible next purchase shares into the mix.  These are BAE Systems (LSE ticker: BA), Royal Dutch Shell (LSE ticker: RDSB) and Imperial Tobacco Group (LSE ticker: IMT).  The reason I am reviewing 3 shares is that I need to make a serious ethical decision on two of the companies before my next share purchase.  BAE Systems make weapons and IMT make cigarettes both of which I believe can easily be argued kill people before their time.

1.    Is the business model simple to understand?

The first criteria is qualitative.  I want to understand how the business I’m buying makes its revenues in less than 10 seconds.  Vodafone provides mobile voice, messaging, data and fixed broadband and has over 40 million customers.  BAE Systems makes products and delivers services covering defence and national security.  Royal Dutch Shell finds new oil/gas reserves, extracts those reserves, refines the reserves into energy products and then supplies those products worldwide.  With Imperial Tobacco it’s all in the name with the focus being manufacture of tobacco products.   All are simple to explain and understand.  All therefore meet my first criteria.

2.    Large and in non-cyclical industries.

All of the companies are within the FTSE 100 so meet the large criteria.  Whether or not we are in recession people/governments still communicate using various non face to face means (Vodafone), want to kill (maybe a little harsh) each other (BAE Systems), need energy (Shell) and smoke (Imperial Tobacco).  So all meet this criteria.

3.    A range of industries

I already own AstraZeneca which is from Pharmaceuticals & Biotechnology, Sainsbury’s which is a Food & Drug Retailer and SSE which is classified as an Electricity Utility.  Vodafone is classified as Mobile Communications although I wonder if in the modern day they are simply a big Communications Utility much like a Water, Gas or Electricity Utility.  BAE would add Aerospace and Defence, Shell would add Oil and Gas Production and Imperial Tobacco would add Tobacco.  The group would then continue to meet this criteria.

4.    Dividends payouts that are above that of the FTSE 100.

 Click to enlarge

I am looking for shares with dividend yields somewhere between the current FTSE 100 yield of 3.69% and 150% of the FTSE 100 yield.

Today 3 of my 4 current shares are now over 150%.  My existing 3 were all green when purchased.  VOD was slightly over 150%, at 166%, when purchased.  The 3 New Contenders all meet my Acceptance Criteria.

5.    An unbroken history of continually increasing dividends plus dividends increasing at a rate equal or greater than inflation.


Click to enlarge

My acceptance criteria under this metric are that the dividends over the medium term must increase at a rate equal to or greater than inflation.   Ideally, for at least the last 5 years dividends this will be year over year increases. 

All have increased dividends at a rate faster than inflation over the medium term.  Shell, however, have not increased their dividends in the last two full years which is a potential concern.  Year to date they have however declared 3 quarters worth of dividends which if the trend continues into the fourth quarter would see dividends increased year on year by 2.6%, when measured in dollars, which is a little better than UK inflation.  I’m therefore going to set Shell to Amber and watch what unfolds closely.

6.    Dividend Cover.

 Click to enlarge

My acceptance criteria requires a ratio of greater than 1.5 for all HYP type shares except utilities where I think that greater than 1.25 is ok.  I accept a lower Dividend Cover for good utility companies as their earnings should be some of the most consistent with little to no cyclicality.  I also don’t like too high a Dividend Cover as I think this encourages CEO’s with delusions of grandeur to run off and make over priced acquisitions, or worse, use the profits not paid as a dividend to buy back the companies own shares thereby maximising their bonuses.  All meet this criteria and so are green.

7.    Operating Cash Flow to Dividends.

 Click to enlarge

Companies through ‘creative accounting’ can make their earnings look good, hence Dividend Cover look good.  Therefore while I look at Dividend Cover, I also set a criteria on Operating Cash Flows compared to Dividends.  The criteria is greater than 2. 

Sainsbury’s, SSE, Vodafone and Royal Dutch Shell all meet the criteria and so are green.  Astra Zeneca and Imperial Tobacco while meeting the criteria have seen falling operating cash flows per share for the last two years.  They will need watching carefully and so I have set them to amber.  BAE has seen operating cash flows to dividends fall by more than two thirds in the last 2 years and to make matters worse these cash flows don’t cover the dividend.  I’m therefore setting BAE to red on this one.     

Conclusion

I now own 4 of my 15 to 20 HYP shares.  Using my acceptance criteria the original 3 still look like good HYP share choices.  I’m also happy to have picked up Vodafone at £1.552 per share.  The only concern is that VOD’s Dividend Yield is more than 150% above that of the FTSE100.  What does the market know that I don’t?

Finally, ignoring ethics who would I choose out of RDSB, IMT or BA today?  I’d exclude BA on cash flow concerns.  Of the other two IMT’s cash flows per share seem to be falling and RDSB is possibly struggling to increase dividends fast enough.  Before deciding I’d probably have a closer look at the other big tobacco company, British American Tobacco (LSE ticker: BATS), where I know their operating cash flow per share is increasing.

What do you think?  Do you own a HYP?  If yes, has it delivered what you thought it would?  Do you have better metrics than the ones I use above?  Do you agree with my metrics?  I’d value any comments or thoughts.

Always do your own research.

14 comments:

  1. Good article, and like the new look -- seems more approachable, somehow.

    Not convinced about Vodafone, mind. I don't like all that debt, especially as I don't think the massive capex that created it is a one-off cost.

    ReplyDelete
    Replies
    1. Hi TI

      Thanks for the compliment on the new look. The site had been around since 2009 and had ended up pretty cluttered as I'd learnt. It was definitely time for a bit of a spring (well winter) clean.

      Cheers
      RIT

      Delete
  2. I was wondering whether you had abandoned the hyp as there had been no additions for the past year! If you carry on at this rate it will take 20 years to complete.

    I think you may struggle to find 20 shares in the ftse 100 which meet your criteria - how about selection from the upper ftse 250 also?

    I think you could add a filter for debt to your list, I am wary of companies who carry high levels as they have less margin for safety. I would also consider the payout ratio - I like to select from companies who's ratio is under 60%.

    Good luck with the experiment!

    John H

    ReplyDelete
    Replies
    1. Hi John

      Thanks for your (and TI's) thoughts on the debt issue. That is definitely an oversight on my part and something I will add for future posts.

      I agree that I'll struggle to find 20 shares that meet my criteria. I'll definitely have to relax them a bit as I add to the HYP. I fully expect to start hunting in the FTSE250 and also duplicating sectors.

      The HYP has been slow going because of the rising FTSE combined with my refusal to sell things as part of my mechanical strategy. If/when we start to see the FTSE falling then the HYP additions will pick up pace.

      Cheers
      RIT

      Delete
  3. They won't fit your criteria for growing dividends but have you ever considered blue chip preference shares for your HYP?

    ReplyDelete
    Replies
    1. Hi Anonymous

      Preference Shares are not something I've had anything to do with. From your perspective what are the pro's and con's over normal shares?

      Cheers
      RIT

      Delete
  4. Hi RIT,

    Very interesting post. I have been accumulating shares for a HYP for some time. We have been adding Pharma and Telecoms companies as these are paying "good" dividends*

    Are you keeping your sights only on the UK? I ask this as you have been writing posts on the macro environments of other markets (is the US overpriced?)

    For example: Europe looks cheap on this basis. Global telecoms and even utility companies in France and Germany pay high dividends and look historically. Obviously this takes on currency risk (or is it currency hedging...)

    On ethics: Fully understand the concerns in this area. Big oil, pharma, tobacco all have pros and cons (as do all businesses:0) Most companies have to survive, ethical companies run the gauntlet of being up against possibly less ethical companies and are at a cost dis-advantage.

    I have invested in the green revolution and other ethical areas and have had mixed results. New technology and stock picking are a no go area due to experience for me hence I keep to the "big" established companies (some of which are in your post).

    I thoroughly enjoy your analysis - thanks and all the best with your investments

    MUFF

    May I suggest a US blog called the dividendmonk which has a good look at VOD (I personally own a few shares) http://dividendmonk.com/vodafone-looks-to-be-a-decent-buy/

    ReplyDelete
    Replies
    1. Hi MUFF

      For the HYP I'm only buying UK Equities. For now that is also limited to FTSE100 companies.

      I keep an eye on the other markets as the HYP only forms a very small part of my total asset allocation. I also have significant European, US, Japanese and Australian Equity allocations. These aren't in the form of a HYP but are mainly held in Index Tracking Funds.

      For more detail have a read of the second link in the post above which provides full details of my invetsing strategy.

      Cheers
      RIT

      Delete
  5. Nice article. Seems to have taken a long time to get to a fourth addition to the HYP. Thinking that some of these could've been added cheaper earlier in the year?

    ReplyDelete
    Replies
    1. Hi David

      VOD is at levels not seen since around August 2011. I couldn't have added at cheaper levels this year. The low price is one of the reasons it's sitting on such an attractive dividend yield.

      Buying or selling within my total portfolio moves at a very slow pace because I am investing mechanically rather than trading. If equity prices started falling then I would become a buyer fairly quickly but with prices rising this year I've been buying assets like gold and index linked gilts over the last 6 months.

      Cheers
      RIT

      Delete
  6. Hi, just stumbled across your blog from a Monevator link. I have also embarked on a HYP and found your analysis interesting. I follow a similar practice but also use P/E to determine if the share is historically under- or over-valued before buying. I am happy to take any significant unplanned capital gains and re-invest the proceeds into another undervalued dividend star. E.g I am looking at selling ULVR at present as it looks overvalued.

    My current portfolio consists of AZN, BA, BP, GSK, MKS, MRW, RDSA, RSA, SBRY, SSE, TSCO, ULVR, VOD. These were acquired over a several years but with the bulk in the last 12 months. It's a little retail heavy at the moment but I intend to add more diversity as prices fluctuate. As I invest for the long term, I can wait for the right opportunity to open up.

    If you don't mind the profit volatility of insurance companies, they provide some of the largest dividend percentages. If you are looking long term (10 years+) then this volatility averages out. RSA has done well for me over the years. I may consider adding another.

    Other contenders on my radar from energy and utilities are: CNA, NG, SVT and UU. These are all too overvalued at present for my liking.

    As a currency and market hedge, I also invest 20% of my savings into a low-fee Emerging Markets ETF - VFEM.

    ReplyDelete
    Replies
    1. Hi Ben

      Thanks for sharing your HYP strategy and current portfolio. The more readers that share the more we can all learn from each other. It also gives more ideas so that we can all go off and do more of our own research.

      Cheers
      RIT

      Delete
  7. My current HYP portfolio consists of BP, GSK, SSE, TSCO. I used to own AZN but got jittery and sold when it peaked up. ULVR is my most considered but still not bought choice and I ruled VOD out due the size of my existing exposure to them through FTSE trackers. Not a HYP share by any means and dilutative against the FTSE dividend rate I also own JMAT which I see as a play on commodities, especially PGMs and long term environmental and technological trends.

    ReplyDelete
    Replies
    1. Hi OIMO

      Thanks for sharing. Some good HYP shares there. A match on SSE. I considered GSK but went for AZN in the end. Similarly I considered TSCO but went for SBRY. As detailed above my next purchase is likely to be RDSB where you went for BP. It seems we have similar thinking though.

      ULVR is definitely on my watch list with (from memory) a long history of incerasing dividends. I haven't gone as far as a really detailed analysis yet because the yield is quite low compared to a lot of other HYP contenders I'm currently eyeing up.

      JMAT is also on my watchlist but it does nothing more than sit close to the bottom of that list for now.

      Cheers
      RIT

      Delete