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4月

Three ways to ‘stress test’ dividends – MoneyWeek

Wearefansofgenerousblue-chipdividendpayers–withoutthem,it’sbeenhardtomakeanymoneyfromFTSE100stocksforadecade,ascapitalgainshavebeennighonnon-existent。

Thedisciplineofpayingregulardividendsisalsogoodformanagementteamsthatmightgetdistractedintotakingunnecessaryriskswithyourcash。

Butmanylargecapsarenotverygenerous–theindexasawholeyieldsjustunder3。

5%。

Withtheretailpriceindexrisingat4。

7%ayear,that’snotenoughtostopyoulosingmoneyinrealterms。

Asabasic-ratetaxpayer,youneedatleast5。

3%tobreakevenandthatcurrentlylimitsyoutofewerthantenFTSE100stocks。

Setthebarat,say,6%,andyouaredowntojustfour,allofwhicharefinancialfirms(threeinsurersandahedgefund)。

Sowhereelsecanyoulook?

Oneanswerisamongsmaller-capfirms,where6%-plusyieldsareavailablefromarangeofsectors。

However,withsmallcaps,youcouldbetakingonmorerisk。

Howdoyouseparatetheshort-termdividendbribersfromthelonger-termsteadypayers?

Onceyou’veidentifiedanattractiveyield,herearethreewaystotestwhetherit’ssustainable。

Doesthefirmgenerateconsistentfreecashflow?

Whenitcomestodividends,cashisking。

Sure,afirmneedstogenerateaprofittooanddecidehowmuchofitwillbepaidoutasadividend(themorethat’spaidout,thehigherthepayoutratio),butwithoutconsistentcashflowithaslittlehopeofsustainingagenerous(6%+yield)dividendpolicy。

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Oneofthemostpopularmeasuresforcomparingstocks–thedividendyield。



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Thereareseveralcash-flowfiguresyoucanlookat,includingafirm’scash-flowstatement。

However,thekeyoneisfreecashflow。

That’scashavailablefromoperatingactivitiesonceyoudeductthestuffthathastobepaid,suchasloaninterest,taxesandmaintainingthelong-termassetbase。

It’sconsistencyyouarelookingfor。

Soideallyyouwantfiguresfromthelastthreeorfiveyears。

Iftheyswingwildly,veeringintonegativeterritory,becautious。

Emerging-marketsfundmanagerCityofLondonInvestments(LSE:CLIG)cutsthemustard。

Theyieldis6。

8%and,despitedifficultconditionsinemergingmarkets(whichhavedentedassetsundermanagementbyonesixth),thefirmincreasedsalesandprofitsinitslateststatement。

Freecashflowgenerationhasbeenconsistentforthelastfiveyears,helpingthedirectorsmorethandoublethedividendsinceflotationin2006。

Isthedividendcovered?

Howmanytimescouldthecurrentyeardividendhavebeenpaidoutofprofits?

Thehigherthebetter,asdirectorscouldhavescopetoraisefuturedividends。

Thestandardtestistocomparetheprofitaftertaxfigureintheprofitandlossaccounttotheordinarydividend(interimandfinal)justbelowitasamultiple。

Oryoucancompareearningspershare(EPS)tothedividendpershare(DPS)。

SoifEPSis45pandDPS22p,dividendcoverisjustovertwo。

That’sagoodlevelofcoverforlargecaps,althoughit’softenhardtofindamongsmallcaps。

Herearound1。

5isacceptableasabasefigure。

Butdon’tstopthere。

Theback-upcalculationthat’sworthdoingisthecashflowversion。

Thereareseveral,butmyfavouriteistocomparefreecashflowpersharetothedividendpershare,againwithaminimumof1。

5times。

So,forexample,carparksoperatorandpropertyfirmTownCentreSecurities(LSE:TCSC)mayboastayieldof7。

2%covered2。

9timesbyprofits,butfreecashflowcoverisjust1。

1times。

ConstructiongroupMorganSindall(LSE:MGNS),however,offersayieldof6。

4%,butitisalmosttwicecoveredbyprofitsandmorethanfivetimescoveredbyfreecashflow。

Arethedirectorscommittedtodividendgrowth?

Incomeinvestingisaboutconsistency。

It’snogoodifdirectorstrytoimpressyouwithaquickdividendboostifthey’venotrackrecordinmakingregularpaymentsandincreasingthemovertime。

Therearetwowaysyoucangetafeelforhowreliableahighyielderwillbeinthefuture。

First,lookatthedividendgrowthrateoverthreetofiveyears。

Youwantasensible,sustainedrateofgrowth。

It’snoguarantee,butitsuggestsadegreeofcommitmenttoshareholders。

AstheMotleyFool’sMaynardPatonnotes,thisismorelikelywhenyouhave“dividend-devoteddirectorsatthehelm”。

AtCityofLondonInvestments,MorganSindallandTownCentrethetopbrassownadecent(over10%)stakeandcollectasteadyincome。

Soalthoughtherearenoguarantees,theywon’tchangedividendstrategy,atleastyourmaininterestasanincome-seekerisalignedwiththeirs。



ThisarticlewasoriginallypublishedinMoneyWeekmagazineissuenumber574on2February2011,andwasavailableexclusivelytomagazinesubscribers。

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