End 2014 - Portfolio Review

As I get older, the time seems to speed up - this past year has gone by in a flash! Puts me in mind of a song by the late Sandy Denny 'Where Does the Time Go'.

Across the evening sky all the birds are leaving

But how can they know it's time for them to go?

Before the winter fire, I will still be dreaming

I have no thought of time

The early part of the year was partly spent writing my latest ebook DIY Income which was self-published in May - sales are slowly starting to build.

The other main event of this year was my house move in July - it takes a little while but slowly settling into my new surroundings (I think!).

Of course, a big surprise was the changes to personal pensions announced by the Chancellor in his Spring budget. This has certainly shaken up the pension annuity industry and has resulted in a radical rethink of my own drawdown plans from next April. This is partly also the result of a doubling of my SIPP charges with AJ Bell Youinvest.

The Chancellor also announced a significant increase in the ISA limits to £15,000 from July.

Turning to my portfolios and following on from my half year review at the end of June, I have just completed a review - sipp drawdown and ISA - for the full year to the end of December.

As many readers of this blog will know, my portfolio is allocated between fixed interest (40%) and equities (60%), which in turn are divided between individual shares and  investment trusts.

Since the start of 2014, the FTSE 100 is down 183 points -2.7%  closing at 6,566 - if we add on say a further 3.5% for dividends paid, this will give a ballpark figure of just 0.8% total return for the full year. Returns on capital have been just as difficult with savings accounts -  the Bank rate has remained at a record low of 0.5% and the savings rate on my instant access account with the Coventry is 1.5%, and on its cash ISA, 2.75% (4 yr tie in).

Shares

My resolution for 2014 was to try to become a little more patient with existing share holdings. There have been only a couple of sales - specialist LED lighting company Dialight was disposed in January following a further warning on profits and in March, I decided to take profits on Carillion and recycled the proceeds into a repurchase of engineer IMI Group.

Once the house situation became clearer in the Summer, I increased further the number of shares in my ISA portfolio in the second half. I have added brokers Charles Stanley and Hargreaves Lansdown and also spreadbetting company IG Index. Finally, during the downturn for commodity shares in December, I topped up my holding in BHP Billiton.

As last year, the individual shares have been mixed, providing a total return of 3.4% over the 12 month period. The better performers have been Reckitt & Benckiser (again) up 14.9% including the recent spin-off of Indivior,  retailer Next +23.8%, accounts software specialist Sage Group +27.2%, insurer Legal & General +23.8% and tobacco company Imperial +27.3% (all figures include dividends paid). The returns have been held back by the well documented dire performance of my two supermarket shares. Tesco is down 40% and has slashed its interim dividend, Sainsbury has fared a little better and is down only 30%. I topped up my holding in both at the end of September - a tad prematurely as the share prices continued to fall in October. I am hoping this sector will see some modest recovery over the coming year. (If the supermarkets are excluded, the total return figure would increase to 6.6% - hey ho!!)

Others that have struggled to make much progress during the year are one-stop commodities play, BHP Billiton (again), small caps Nichols -22% and Plastic Capital down -10%, oil sevices group Amec Foster -17.5% and large cap pharma GlaxoSmithKline -10% which has been under a cloud for most of the year following the bribery scandal in China.

Whilst the capital values of the individual share prices will always swing around - some have been very volatile this past few months - it is reassuring to see the predictable dividends rolling in month after month. Total income received on the shares - the main purpose of holding equities - over the period is 3.6%. Collectively, dividends have increased by an average of 13.0% over the year - the highest increases have come from Next 23%, Legal & General 22%, AMEC 15%, BSkyB 18.1%, and Unilever 15.4%. The shares with the lowest increases were Centrica 4.0%, Billiton 4.3%, Sainsbury 3.6%, Reckitt 2.2% and finally Tesco which cut its interim dividend by -75.0%.

Investment Trusts

Unlike shares which have been volatile, the trusts have had a relatively steady if unexciting year - just the way I like it! Over the 12 month period, I have topped up my holdings in Murray International, City of London (x2 April and Sept) and Edinburgh. Also I  added Invesco Income Growth to my ISA in June.

The benchmark for my basket of investment trusts portfolio is Vanguard All World High Yield ETF (VHYL). Over the past year this has seen a total return of 7.8% including 3.7% income. I am impressed with both income and capital return in my first full year of holding the ETF.

The total return for my basket of trusts over the year was just ahead of the shares portfolio at 3.6%.

The better returns came from Asia focussed trusts - Aberdeen Asian Inc., Schroder Oriental and Henderson Far East with 7.9%, 12.6% and 8.5% respectively, Edinburgh up 11.6% and fixed income specialist New City High Yield 6.4%   The only trust that has struggled for me this past year is Dunedin Smaller Companies (-17%) mainly due to a widening of the discount to NAV.

Income yield from the trusts portfolio has been steady at 3.7%. Most trusts have continued to bolster income reserves this year and therefore the collective increase in dividends has been just 4.7%. The highest increases were Aberdeen Asian 10.5%, Murray International 9.4% and Aberforth 7.2%. The lowest increases came from Dunedin Income 0.9%, New City High Yield 2.2% and Dunedin Smaller Companies 3.0%

Fixed Interest

Total return for the 12 months was 10% including income of  6.5%. Once again - I think 3 years running, the best performing sector of my portfolio.

The best performance came from Skipton BS PIBS which provided a return of 18% and Lloyds Bank preference shares 17.4%.

The Complete Basket

As a whole, the portfolio has advanced 5.4% over the past  year including the payment of 4.5% income.

Just comparing my actual investment income received for 2013, I am pleased to see an increase of 12.2% for 2014. Some of this will, of course be due to the income from the new ISA contribution since last April. Bearing in mind that 40% of the portfolio is represented by PIBS and fixed income securities which provide no increase in income year-on-year, I am more than happy with this.

Learning Points

I am fairly happy with my efforts to curtail my trading this past year which was the main task I set for myself at this point last year.

Once again, the collective investment trusts have provided the better return compared to individual shares with less volatility - only 0.2% but this will be the 5th year that I have just fallen short of out-performing the professionals.

I will give a little more consideration to maybe increasing the balance between the two - possibly 70% or 75% collectives (currently 65%). I will also take a little more interest in the Vanguard ETF with a view to topping up - the only reservation is the lumpiness of distributions - I am never quite sure what I will receive until it arrives!

As ever, I would be interested to hear how others have done over the past 12 months - leave a comment if you keep track of your portfolio.

Finally, wishing all readers a happy, healthy and prosperous New Year!

Next - Christmas Trading Update

This FTSE 100 retail chain was only launched in February 1982 and the first store opened with an exclusive coordinated collection of stylish clothes, shoes and accessories for women. Collections for men, children and the home quickly followed. NEXT clothes are styled by its in-house design team to offer great style, quality and value for money with a contemporary fashion edge.

Today NEXT trades from more than 500 stores in the UK and Eire and almost 200 stores in more than 30 countries overseas. Online shopping was introduced in 1999 and the entire book became available to shop from on the internet, page by page – another first in home shopping in the UK. NEXT Directory now has around 4m active customers and also serves customers in around 70 countries outside the UK.

In October Next cut its profit forecast by 3% to £770m after a mild autumn reduced demand for winter clothing. However, in its latest trading update issued today for the period end October to 24th December (link via Investegate), the company says it has recovered some of the lost ground and profits are likely to be £5m higher at around £775m. This would be an increase of 11.5% on the previous full year.

Year-to-date sales are up 7.7% with a strong contribution once again from online directory sales - up 12.9%.

More good news for income seekers, in addition to the 3 special dividends paid out over the past year totalling £1.50 and the 50p interim dividend due next week, there will be yet another special dividend of 50p payable 2nd February.

The update has been well received and at the time of posting, the share price is up just over 3% at £67.60.

More on this following the full year results 19th March.

Finsbury Trust - Final Results

This trust is not the highest yielder but is the top UK Income Trust in terms of net asset value and share price performance over five and ten years, its returns far outstripping those of the FTSE All-Share index. A sum of £1,000 invested 10 yrs ago would now be worth £3,388 compared to a total return of £2,202 from the benchmark FTSE All Share index.

At around 2.1%, its yield is one of the lowest in the sector but its aim is capital and income, with a total return in excess of the FTSE All-Share. However, the trust's portfolio is constructed without reference to a stock market index.

Nick Train

Long standing manager Nick Train’s approach is based on that of Warren Buffett’s and involves building a concentrated portfolio of “quality” companies that have strong brands and/or powerful market franchises.

The characteristics that define a quality company for Lindsell Train are:

• durability – companies that can prosper through business cycles for many years to come;
• high return on equity – companies with the ability to grow earnings year-in, year-out are favoured over those with rapid short term growth, but uncertain long term prospects; and
• low capital intensity/high free cash flow generation – companies that do not have to make heavy balance sheet investment to generate earnings growth.

He holds shares for the long term regardless of short-term volatility, aiming for them to double or more in value over time. This results in extremely low portfolio turnover, which saves on transaction costs. These costs over the past year amount to just 0.09% of net assets. The trust's total expense ratio remains reasonably low at around 0.8%.

Top five portfolio holdings are: Unilever 9.0%, Diageo 8.3%, Pearson 7.4%, Reed Elsevier 7.2% and Heineken 6.8%.

Results

The trust has today announced results for the full year to 30th Sept 2014 (link via Investegate). Share price total return is 8.6% compared to 6.1% return for the FTSE All Share.

Over the past year the dividend has increased by a respectable 7.6% to 11.3p (2013 10.5p). Revenues were 12.6p and therefore there is a small surplus after accounting for payments of dividends which will further bolster the dividend reserves.

Commenting on the past year, manager Nick Train said his portfolio was focussed on quality rather than size "Biggest is not necessarily best, if it's investment returns you're after. We believe what really matters is the calibre and unique nature of the companies you're invested in. This is what makes money over time. And, to reiterate, we think we own a collection of special companies".

You cannot argue with the returns he has provided for shareholders over many years. I took an opportunity to top up my holding in October and obviously very happy to continue holding for the long term.

Berkeley Group - Interim Results

Berkeley is a fairly recent addition to my portfolio - here’s a link to the opening post.

They have today issued results for the half year to end October 2014 (link via Investegate). Berkeley has built and sold 1,372 new homes in the past 6 months. This was around 900 less than the same period in 2013 however the average price was 85% higher - £649,000 compared to £350,000 in 2013. This has resulted in revenues up 24% at £1.022m. Pre tax profits are up by a stonking 79.9% at £304.9m (2013 £169.5m) and underlying earnings per share are up 28.9% at 128.9p (2013 100p).

The board have declared an interim dividend of 90p payable in January 2015 (xd 19th December). The Group are on target to deliver a further 90p dividend in September. The longer term plan is to return a total of £8.66 in dividends over the following 6 years to 2021.

During the period, the Group sold a portfolio of approximately 10,000 ground rents for £99.8m and a gross profit of £85m.

Berkeley remains ungeared with net cash rising from £129.2m to £148.4m.

Commenting on the interim results, Chairman Tony Pidgley CBE said: "I am pleased to report a further period of strong performance which underlines the benefit of having the right strategy to operate in a cyclical market…In terms of Berkeley's wider contribution to the economy, we have created over 1,000 new jobs in the last six months, now directly sustaining some 12,000 in London and the South of England, and we are providing structured training to over 700 young adults. We have built some 10% of all new housing and 10% of all affordable housing in London over the last five years. All of this demonstrates the significant contribution that a vibrant house-building industry can provide to the UK economy".

Commenting on the results, Managing Director Rob Perrins said: "The first six months of this year have seen a return to normal trading conditions from a high point in 2013, which has continued to provide a stable operating environment for the business. The demand for new homes, against the backdrop of a shortfall of new housing under construction, continues to underpin the market. In this context, the Board expects full year earnings to be in line with current market expectations, ahead of previous guidance, and for the following two years to remain in line with previous guidance".

There can be no doubt these are excellent figures. The results were well received by the market and the share price was up over 3% to close at £25.97. The yield is 6.9%.

DS Smith - Interim Results

DS Smith is a leading provider of corrugated packaging in Europe and of specialist plastic packaging worldwide. They operate across 25 countries and employ around 21,500 people. It is the UK's leading producer of recycled paper board and manufacturer of corrugated packaging

The company has developed to become a European leading provider of consumer packaging with emphasis on state-of-the art packaging design. It is the largest paper recycler in Europe, collecting around 5.4m tonnes annually, a market leading recycling and waste management company

DS Smith rejoined my portfolio following the final results last June - here’s a link to a post.

The company has today reported a strong set of interim results for the half year to end October (link via Investegate) with adjusted profits up 17% (constant currency) at £176m and earnings per share up 24% at  12.9p.

Chief Executive Miles Roberts said: "We are pleased with performance in the first half of this financial year. We have continued to make good progress with our customers, benefitting from our differentiated commercial offering, and this has translated into strong financial performance, with a particularly good progression on margins and returns as well as excellent cash flow generation. We continue to actively manage our business portfolio and are excited by the opportunities for the Group.

Our outlook remains positive as the business continues to grow, despite ongoing economic headwinds in many of our markets. The Board expects continued performance in line with the Group's medium term financial targets."

Free cash flow is strong at £151m (£110m 2013). Net debt reduced to £694m (from £827m - April 2014).
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The group has increased the interim dividend by 16% to 3.7p (3.2p 2013) - I‘m not sure why investors have to wait 6 months to receive it! The target dividend cover is 2.0x  - 2.5x earnings

Since the period end, the company has announced the acquisition of Andopack, a Spanish corrugated packaging business. They have also announced today  having entered into a letter of intent with a view to acquiring a corrugated packaging business in Turkey and Greece.

The results were well received by the market and the share price was up over 5% closing at 304p. More on this following the final results next June.

Sage Group - Final Results

Sage is a global leader in the provision of business management software and services for small and medium sized businesses. Products include accounting and payroll, enterprise resource planning and customer relationship management.

Sage Group currently operates in many European countries, North America, South Africa, some N African and Middle East countries, Australia, New Zealand, Malaysia, Singapore and most recently Brazil.  Sage has continued to grow its business both organically and via acquisitions and currently has over 6 million customers worldwide and a market cap over £4bn

Sage has set itself the goal of growing organic revenue at 6% a year in the medium-term, with increasing profit margins and hence even faster growth in profits.

Results

The Company today announced final results for the year to 30th September 2014 (link via Investegate).Organic revenues increased 4.9% to £1.3bn, underlying earnings were up 8% at 22.69p and adjusted dividend is up 7.1% at 12.12p (rebased).  The dividend for the year is covered 1.9x by underlying earnings per share.  They are on track to deliver organic revenue growth of 6% in 2015 combined with 28% operating profit margins.
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Sage announced a strong acceleration in adoption of Sage One - their cloud solution for smaller businesses. It is now present in 10 markets and approx.150% increase in paying subscriptions to 86,000 (2013: 35,000), driven by strong run-rates in the UK & Ireland and South Africa.

Commenting on the results, new CEO Stephen Kelly said:  “Our financial performance demonstrates the strength of Sage's global business and the quality of relationships it has with millions of SME customers worldwide.  Looking ahead, I believe that Sage, as a trusted partner to our customers, can be even more instrumental in supporting the success of SMEs around the world. I look forward to building on Sage's technology leadership, both in the cloud and on-premise, together with our outstanding customer support, to the benefit of our current and future SME customers."

For investors, the best thing about Sage is that it generates a lot of cash, and it likes returning that money to shareholders. The Group remains highly cash generative with cash flows from operating activities of £382m. They propose to pay a final dividend of 8.0p in March 2015.

I particularly like businesses with high barriers to entry - Warren Buffett calls these ‘moats’. I believe Sage is such a company - once a customer has a computer system in place that carries out essential activities such as accounting and payroll, for instance, they are unlikely to go through the expensive and risky process of changing it. Analysts believe this dependency on Sage gives the business the ability to increase prices and boost profits/dividends further.

Sage was added to my ISA portfolio around a year ago at 369p. Today's results have been well received with the share price up over 4% at 422p and yield of 2.9%.

Sage was the very first share I purchased in what was known as a single company PEP some 20 years back. I sold it at a handsome profit a few years later leading up to the dot-com bubble. I am pleased to return to holding this as an income investor many years later. There is always a degree of uncertainty following management changes at the top, but I am encouraged by progress made under the new team and happy to continue holding this leading software provider

As always, please DYOR.

Shares Portfolio - November Update

I last updated on my shares portfolio in August. Since then I have made just one further purchase - small cap financial services firm, Charles Stanley in September.

The portfolio has therefore expanded to a total of 24 shares and I have allocated £1,500 to each of the additions making a total capital input of £36,000.

Although this is demonstration income portfolio, it mirrors my own holdings in all aspects except weighting for each share. As with my investment trust holdings, I withdraw most of the income from my shares for living expenses. With this demonstration portfolio I will reinvest the income at the end of each year either into an additional holding  or recycle the income generated into one of the existing shares.

With any portfolio, it is rare for all shares to travel in the same direction at the same time - this is why its good to have a mix of shares from diverse sectors of the market. It is therefore no surprise that performance since the start of the year has been mixed. Some shares have struggled to make progress this year - notably global miner BHP Billiton, owner of British Gas Centrica, more recently, oil services specialist Amec Foster Wheeler and engineering group IMI. Of course, the supermarkets Tesco and Sainsbury have slumped following the well documented problems and these two have impacted quite heavily on the portfolio, reducing the overall returns by around 3.5%. On the other hand, there have been some good gains to even things up - Unilever, Reckitt, Next, Imperial Tobacco, recent additions IG Group and Legal & General

At the close of business yesterday, the FTSE 100 was 6,722 - still below the level of 6,749 at the beginning of January 2014. The shares portfolio has returned 3.4% year-to-date which includes dividends of 3.7%.

The effect of the additions in recent months means it is difficult to make an accurate comparison. The only way to do this would be to unitise the portfolio. Also, some of the additions made later in the year have not yet contributed a full years dividend. However, it appears the portfolio has made a little progress since the last update in August.

Dividends

As I have said in previous posts, I am not particularly focussed on capital values - share prices will rise and fall. The dividend income is far more stable and predictable. It is well documented that, over the longer term, dividend growth and, where appropriate, the reinvesting of dividends will provide the lion’s share of overall returns from an equity portfolio.Dividends are the most important aspect for me and these continues to roll in very much as expected with the exception of Tesco. 

All the companies in my portfolio have declared full year dividends for 2014. Most have delivered above-inflation uplifts, and several have increased their dividend by over 20% - IG Group, DS Smith, easyJet, Legal&General, Sky and Plastics Capital. The average increase for the portfolio over the past year is 13% which has made quite a difference to income this year. According to the rule of 72, if dividends were to increase at a similar rate each year, my dividend income would double every 5.5 years. 

Of course, I am not expecting double digit income growth every year. The interim dividend for Tesco was reduced by 75% and the final dividend is likely to be significantly lower next year. Likewise with Sainsbury.

Reinvestment

Commodities have been under pressure for most of the year. Working on the principle of reversion to mean, I have decided to top up my holding of BHP Billiton. At the current purchase price of £14.60 - down from £19.85 in August - the yield is now approaching 5.0% subject to currency exchange. The surplus dividends of £1,416 will cover the purchase of a further 96 shares after dealing costs making a new total of 166 shares.

Here’s the current portfolio 

(click to enlarge)

As ever, slow & steady steps…..

Charles Stanley - Interim Results

Charles Stanley  is one of the UK's leading independently owned, full service stockbroking and investment management groups. It is one of the oldest firms on the London Stock Exchange with its origins in a banking partnership established in Sheffield in 1792. Over the past two centuries, it has grown both organically and via acquisitions and developed into the modern day stockbroker firm offering a wide range of services to both individual investors and corporate clients.

This is the most recent addition to my portfolio. Prior to purchase, the share price had fallen around 40% - I am not the best when it comes to timing of my purchases (and sales!), so I am pleased to see the share price appears to have stabilised over the past couple of months.

The company have issued its half-year results to end Sept 2014 (link via Investegate). Revenues for the period increased 4.1% to 72.9m (2013 £70.0m) however costs were significantly higher at £77.0m. Excluding one-off costs, underlying profits were just £1.5m compared to £8.0m in the first half of 2013.

Notwithstanding the reduction in profits, the board felt sufficiently confident to maintain the interim dividend at 3.0p - the shares trade ex dividend 5th December.

Long standing CEO, Sir David Howard has stepped down and is replaced by Paul Abberley former chief executive of Aviva Investors. He has commenced a strategic review of the business to identify the measures required to enhance the profitability of the Group and drive its long-term growth, and will present to shareholders in due course.

Charles Stanley Direct

One of the considerations for my purchase (and also Hargreaves Lansdown recently) was the potential to tap into what I believe will be a growth area in the coming years - that is the self-directed diy investor.  The roll-out of RDR has no doubt made the provision of financial advice and personal investment services more costly to deliver. This increasing cost will make advice-led service unaffordable and/or inappropriate for clients of more modest means with smaller portfolios.

CSD offer the usual dealing a/c, ISA & Junior ISAs and SIPPs. Charges are very competitive and particularly attractive for the modest portfolio holding of under £50,000 as the charges are based on a percentage of the holding - 0.25%. This compares favourably with the likes of Hargreaves Lansdown 0.45% and Fidelity 0.35%.

It is encouraging to see this is making good progress with a further 3,300 new a/cs added in the past 6 months taking the total to over 17,500. Revenues from CSD rose 66.7%.

Hopefully the strategy review will be implemented in the coming months and the company can start to rebuild and restore a more profitable operation.

At close, the share price was down around 2% at 308p. More on this small cap following the full year results.

Reversion to Mean

We are often advised to build a diversified portfolio - don’t put all your eggs in one basket. This means looking at asset allocation and spreading your investments between different classes of asset, market sectors and even differing continent around the world.

One reason for this advice is because of the cyclical nature of markets. Some of the time equities will do well, at other times bonds will be the place to invest. In 2001, a smart move would have been gold which over the next 10 years increased from $200 to $1,200. Whichever asset you look at, there is a pattern of movements up followed by the inevitable move down again. Over the longer terms, the average between the peaks and troughs for any asset class can be plotted or calculated and the movements towards this average is called mean reversion.

Whilst these cycles are easy to identify in retrospect, it is not easy for me or, I suspect, the average investor to correctly identify the turning point of these cycles.

Rebalace

The point of building a diverse portfolio is to try and reduce volatility. As one sector of the market is doing well, another will be going through a difficult time. Rebalancing your portfolio, say once per year, involves selling some of the assets which have done well and reinvesting the proceeds into the sectors which have underperformed.

The only sensible reason to do this is because of the investing principle known as reversion to mean. Whilst many forms of investments, including equities, can trade above or below their long term average - often for surprisingly lengthy periods - in the long term, they always move back in line with that average sooner or later.

A Measure of Long Term Average

Its all very well understanding the theory of mean reversion, but how can small investors apply the theory in practice to better manage their portfolio?

For me, it helps simply to understand that the shares in my portfolio that have a good run one year, may underperform the next year. With my investment trusts for example, Aberforth - a smaller companies specialist- had a stellar run in 2012/13 with a combined return of 100%. I know that this year or next, there will be a corresponding underperformance whilst another sector of the market has its day in the sun.

I like the contrarian approach of Alastair Mundy who manages one of my long-held investment trusts, Temple Bar. Much of investment management is premised on the view that there are excellent companies that consistently beat their peers and weak companies that consistently underperform.  Mundy takes the opposite view believing that most companies revert to their long term mean. He believes most companies are normal and that if he buys the assets cheaply enough, the share price will rise and return to its long term average. His track record is pretty impressive - the trust has returned an average (cagr) of 10.6% p.a. over the past 10 years compared to 7.8% for the benchmark FTSE All Share index.

TMPL v FTSE All Share
courtesy of Digital Look (click to enlarge)

Looking at the wider picture it is always a good idea to check out the cyclically adjusted PE10 ratio or CAPE from time to time. This measures the price/earnings ratio of an index such as FTSE 100 averaged out over a 10 yr period to iron out the anomalies that a shorter period may give. At the present time, UK equities appear to be around the p/e 12 level, that’s below their long term average of around 15 or 16 - hopefully at some point they will revert to this average or rise above as it did around the turn of the millennium.

Rather than try to recreate the illustrative charts, here are a couple of links to articles by UK Value Investor and also RIT.

Of course, mean reversion can never give a clear and/or specific guide to timing, as I said earlier, markets can and do move against the tide for lengthy periods - a little like the cartoon character running off the edge of the cliff. For the average small investor however, if you understood nothing more than the fact that the markets and the economy move in cycles you would be far ahead of the majority of investors.

Edinburgh IT - Interim Results

Established in 1889, Edinburgh IT this year celebrated its 125th anniversary.Previously run by star manager Neil Woodford, it is one of the largest investment trusts on the market with assets approaching £1.5bn. The trust invests primarily in UK securities with the long term objective of achieving:

1. an increase of the Net Asset Value per share by more than the growth in the FTSE All-Share Index; and,
2. growth in dividends per share by more than the rate of UK inflation.

Although this is a UK income trust, the manager is permitted to invest up to 20% of the portfolio in overseas listed holdings. Around 15% is currently allocated including Swiss Pharma, Roche and US tobacco firms Reynolds and Altria - these three are top 10 holdings and currently account for 12.7% of the portfolio.

Edinburgh is been one of the cornerstones of my income portfolio held in both Sipp drawdown and ISA. I took the opportunity to top up my ISA holding again earlier in the year. Mark Barnett took over as lead manager from end January 2014. He also manages Invesco's Income and High Income funds which have combined assets of over £20bn - must be a busy chap!

It has this week published  results for the half year to 30th Sept 2014 (link via investegate).

The Company's share price, including reinvested dividends, rose by 4.6% during the past 6 month period, compared to a rise of just 1.2% (total return) by the FTSE All-Share Index.

The trust yields 3.7% based on the current share price of 640p.

Charges & Borrowing

Following the departure of Neil Woodford, the independent Board of Directors renegotiated charges at the start of this year. The performance fee has disappeared and the annual charges are reduced from 0.6% to 0.55%. As a result, ongoing charges for the half year are just £3.7m compared to a whopping £15.5m at the same point last year - a saving of nearly £12m!

Shareholders are also set to benefit from the significant savings in borrowing costs as the £100m 11.5% debenture has now been redeemed and replaced with a lower interest revolving facility from Bank of New York Mellon. The interest saving so far is £2.5m and the full year savings should be around £7.5m.

These are significant savings which should translate to improvements in performance and, importantly, a better return for shareholders!

More on this following the full year results, but so far, happy with progress made under the stewardship of the new manager.

Henderson FE Income Trust - Final Results

HFEL is a long standing member of my ISA income portfolio. It seeks to provide a high level of dividends, as well as capital appreciation over the long term, from a diversified portfolio. The principal areas of investment focus are Taiwan (20%), China (18%),  Australasia (17%), Singapore (9%), Hong Kong (12%) and S. Korea (7%).

Last week I posted the results of Schroder Oriental Income which operates in the same areas but with slightly differing weightings for each country.

I last posted on HFEL following the results last November. Yesterday they issued full year results to end August 2014 (link via Investegate).

Building on last years total return of 8.8%, the Company have reported a share price total return increase of 13.5% compared to the benchmark MSCI Asia Pacific index increase of 13.3%.

HFEL is the highest yielding of my 3 Asia-focussed investment trusts. Together they comprise around 9% of my investment trust portfolio. Over the year, dividends (paid quarterly) have been lifted by a very respectable 7% from 17p to 18.2p giving a yield of 5.6% at the current price of 324p. The dividend was comfortably covered by revenue income of 19.3p per share.

Dividends have risen by an average of 7.5% CAGR in each of the past 7 years. At this rate, the dividends will double every decade.

courtesy of ChartGo (click to enlarge)

Last year, Henderson agreed to take a reduction in their annual management fee from 1.0% to 0.9% of the total value of the fund's net assets - there is no performance fee. Fees and expenses for the past year were £4.0m - around 1.2% of net assets and a welcome reduction from the previous year’s 1.4%.

Although capital appreciation is a little weak compared to say Schroder Oriental, the dividend yield is much higher and is very welcome in today's low inflation/low interest rate economy. I am happy to continue holding for the longer term.

Sainsbury - Interim Results

This time last year, Sainsbury was riding high - its share of the grocery market was the highest for a decade at 16.8%, following 35 consecutive quarters of like-for-like sales growth, online sales exceeded £1bn for the first time and the share price was 415p.

A year later sales growth is in decline and the shares have tumbled 37% - to be fair, as far as I can make out they have not done a lot wrong as all the major players appear to have been affected to some degree or other. At the time of publishing their final results in May, sales, profits and earnings were up so I have been awaiting these results in the hope that some light can be shed into the reasons for the slump.

They have today announced half-year results for the 6m to end September 2014 (link via Investegate).

Profit before tax is down less than forecast -6.3%% to £375m (2013/14: £400m) whist basic earnings per share is down 12% to 14.5p (2012/13: 16.6p) . These figures for underlying results excluded a £665m charge, mostly from a reassessment of its store pipeline and a write-down in the value of unprofitable and marginally profitable stores. Due to increased investment in lowering prices to the tune of £150m over the coming 12 months, combined with expected lower profits from its banking operation, Sainsbury warned that its full year profits would likely be lower than last year's.

Despite media speculation last weekend of a cut, the interim dividend has been maintained at 5.0p (2012/13: 5.0p). However, with the forecast of a reduction in H2 profits and a decision to target dividend cover at 2x, it is a probability the full year payout could be trimmed back. It is a little difficult to assess what the figure might be, but based on current analysts' estimates (which obviously may change) this would suggest a figure of around 9.0p which would make 14p for the full year, a reduction of around 17% on the 17.3p paid last year.

Management are implementing a new strategy to address some of the industry challenges.

• A  reduction in capital expenditure from £925m (3% of sales) to between £500m and £550m p.a. over the next three years, approximately 2% of sales;
• To deliver total operating cost savings of £500m over the same period;
• Over the next 18 months, to improve the quality of 3,000 own-brand products, investing in range, innovation, packaging and merchandising, and deliver ethical sourcing in line with their values.
• To reduce the number of large stores from around 40 to just 8
• To better utilise underused space in around 25% of existing stores combined with a target of 100 smaller convenience store openings
• To open 15 Netto stores by the end of 2015 in a joint venture with Dansk

New CEO, Mike Coupe commenting on the new strategy, said:
"Sainsbury's is a great business. Our consistent outperformance of our main supermarket peers over the past five years is evidence of this. We are facing into a once-in-a-generation combination of cyclical and structural change in the industry, but I firmly believe that this strategy, building on our unique heritage and track record of success and delivered by the most experienced management team in retail, will focus and energise our business to the benefit of customers, colleagues and shareholders alike."

The results received a mixed reaction and by the end of today the share price finished just 3p lower at 265p. If my guestimate of 14p dividend is correct, this gives a current yield of 5.3%.

Last month I topped up my holding at 260p - my breakeven figure is 300p so I’m hoping the recent turbulence is starting to settle down. Whether that was a good move or not only time will tell.

More on this following the Christmas trading update.

Schroder Oriental Income Trust - Final Results

This is one of my long-standing income trusts providing exposure to the Far East and Australian markets. I last updated on SOI following last year‘s FY results.

The trust has today announced results for the full year to end August 2014 (link via Investegate).  Following on from last years return of 15.6%, share price total return for 2014 has increased by a very acceptable 15.2%, compared to the benchmark index of 11.3%. Over the past 5 years, average returns have been 15% per year (CAGR) compared to 7.0% for the benchmark MSCI Asia Pacific Index.

Income has been curtailed by foreign exchange headwinds and has fallen 7% to 8.12p ((8.74p 2013). However, this still covers the dividend which has again been increased from 7.45p to 7.65p. A final dividend of 3.15p will be paid 28th November. Based on a share price of 193p, this gives a current yield of 3.9%.

Charges

Net assets of SOI have increased some 8% from £395m to £428m. Of course, management fees correspond to the value of net assets and I am pleased to note these have reduced some 7.5% from £5.7m (2013) to £5.3m this year which includes a performance fee of £1.8m (£2.4m 2013). Ongoing charges are therefore reduced from around 1.6% to 1.3%. I am hoping the management may follow the trend of many other leading investment trusts - City of London, Edinburgh are two examples - and abandon performance fees before too much longer. This would make the trust even more attractive to investors - institutional and small retail alike.

The basic fee is 0.75% of the net assets. The Manager is also be entitled to a performance fee of 10% of the amount by which the adjusted net asset value at the end of the relevant calculation period exceeds a hurdle of 107% of the adjusted net asset value at the end of the previous period multiplied by the time weighted average of the number of shares in issue during the year (still with me?!!).

The portfolio is spread far and wide - the main areas for investment are Australia, Singapore, Hong Kong, Taiwan, Thailand, China and S. Korea.

Outlook

Commenting on the year ahead, the manager says: 

"If the hopes for reform may prove misplaced, there are some positive supports for the region. A combination of steady global economic expansion and falling commodity prices is beneficial to the regional export outlook, and industrial and information technology sectors are important components of the equity markets. National balance sheets are also, in general, sound with high savings rates, foreign exchange reserves and positive current accounts. These provide reassurance that the longer-term scope for domestic demand growth in Asia remains ample.

At a stock level we continue to believe that the longer-term case for income investing in Asia remains securely based. The equity markets offer a diverse range of countries and sectors where solid income stocks can be found, and we take comfort in the strong aggregate metrics of the Company's portfolio in terms of superior cash generation, higher than average returns on equity and lower financial gearing".

This holding, for me, has been another solid year and provides a decent level of income combined with exposure to growing economies and emerging markets. The Far East has long been a good hunting ground for the income seeker. I am pleased to see the charges coming down but the performance fee takes the edge off returns - having said that, the returns have outstripped the benchmark index over the past 5 years so, I suppose, no complaints.

I am happy to hold longer term but probably not currently looking to increase my holding.

Cashflow as an Indicator for Sustainable Dividends

I am primarily an investor for income. A large proportion of that income comes from the dividends from my equity portfolio.

When I am weighing up a share for possible addition to my watch list or to purchase, I will usually look at a number of factors -

• dividend yield which is basically the current years dividend as a percentage of the current share price; 
• the dividend cover, which is the earnings per share divided by the dividend per share - preferably 2x or above; 
• the dividend payout ratio, essentially dividend per share divided by earnings and expressed as a percentage - preferably somewhere between 35% and 65%;
• I also look at free cashflow cover (FCF) i.e the cash left over after profits have been reinvested in the business. It is from this spare cash flow that dividends are paid, not its operating earnings.

It is important for me to ensure that the shares I choose to invest in can provide me with a growing income from dividends for many years to come. Of course, there are no guarantees when it comes to the stock market - the problems with Tesco over the past year or two for example, but I believe the more research I carry out prior to purchase, the better chances I will have of making a sound investment decision. This sounds simple, however when looking at a company’s dividend the most important aspect for me to consider is whether it is sustainable over the longer term.

Accounting rules allow companies some discretion regarding the earnings numbers that they release. This can lead to distorted views of how successful a company is and struggling firms can appear as though they are producing stronger results.

Cashflows do not allow the same wriggle-room that earnings offer. If a company has more cash going out than they have coming in, this will be obvious in the cashflow statement. Dividends are paid in cash, so a company that has paid a consistent dividend is likely to have a steady stream of cash coming in. Therefore, these companies possibly have solid business models and are expected to navigate a downturn in the economic cycle more easily. Monitoring a firm’s cash flows year on year will give me a good indication of whether or not the dividend is sustainable. If firms have negative cash flows, but are paying a dividend anyway, I believe they should be treated with caution.

Calculating Free Cashflow Cover

This will require a look at the latest results. Scroll down to the Cash Flow Statement - usually after the Balance Sheet.

Free cash flow cover = (Cash generated from Operations minus Property, Plant & Equipment or Capital Expenditures) / Dividends Paid

A minimum cover of around 1.4x to 1.5x  is usually what I look for to provide a reasonable margin of safety. The higher the cover for free cash flow, the more sustainable the current dividend in my book.

If the FCF is below 1.0x or even negative, then I consider the dividend is possibly under threat - the company may be able to maintain dividend payments for a short period by extra borrowing but this would not be sustainable in the longer term.

It is also worthwhile checking back over a couple more years to assess the level of FCF cover and to see if the cover is rising or falling - one years figure can be misleading.

A Couple of Examples from my Portfolio

Earlier this year, retailer Next reported its final results - here’s a link via company website. You will find the Cashflow Statement (Unaudited) some ¾ down the report.. Cash generated from operations (before tax) is £766.8m, payments on capital expenditure to acquire PP&E is £102.6m and therefore deducting this from cash generated leaves £664.2m.

The dividends paid is £164.8m. Therefore Free Cashflow Cover is 664.2/164.8 = 4.03x - I would regard this level as very safe.

Another of my holdings is media company BSkyB which reported full year results in July - link via Investegate. Cash generated from operations was £1,769m (before tax), payments for capital expenditure on PP&E was £241 so again, deducting this from cash generated leaves a figure of £1,528m.

The dividends paid for the year were £485. Therefore FCF Cover is 1528/485 = 3.15x - slightly less than Next but again, a very comfortable level of cover.

Payout Ratio

Another important factor to consider regarding dividend sustainability is the payout ratio; while high dividends are important, a lower payout ratio - under 50% - tends to be a positive indicator. If a company is paying out nearly all of its earnings in dividends, this may be a sign that the dividend is not sustainable. Also, if the payout ratio is increasing over time, this might indicate that earnings growth is not keeping up with dividend growth, and the dividend is not sustainable. Companies with strong cash flows and low payout ratios have room to grow the dividend, and also tend to exhibit positive price appreciation. The ideal for me is a ratio somewhere between 40% - 65%.

Shares that offer a more sustainable dividend often fall into so called defensive sectors such as utilities and telecoms (did someone say supermarkets?), as these companies are not as negatively affected by a market downturn. When the economy retreats, as it has in recent years, consumers will limit their discretionary spending, so firms that sell non-essential products should see some decrease in sales. This can make sustaining a dividend particularly difficult for these companies. Firms in areas such as telecoms and utilities sell products and services that consumers have little option but to purchase. As a result it is easier for them to sustain a dividend, and suggests that they will make it through a recession more easily.

Besides finding the right balance between dividend yield and dividend growth, companies with favourable cashflows are therefore the companies that I try to target as core holdings for my equity income portfolio.

Take it easy - enjoy the wonderful autumn colours!

Imperial Tobacco - Final Results

Imperial are the 4th largest global cigarette manufacturer and world leaders in high margin premium Cuban cigars and fine-cut tobacco. Some well known brands include Gauloises Blondes, JPS, Lambert & Butler, Golden Virginia, Drum and Rizla papers.

The share price was £23.60 at the same time last year and IMT have had a decent run up 16% to (currently) £27.50 supported by a solid 5% dividend yield.

Imperial have today released full year results for the 12 months to 30th September 2014 (link via Investegate).

Group net tobacco revenues totalled £6.5bn, up 2% underlying but down 6% in actual terms. Imperial said underlying volumes of growth brands rose 7%, driven by sales growth and brand migrations. Its growth and specialist brands also made up 54% of underlying tobacco net revenue, up 3%.

It said it performed strongly in growth markets outside established areas such as Europe and the US. It also said it had reduced stock held by distributors, particularly Russia and Iraq and had saved more than £60m during the year, putting it on track to save £300m a year by 2018.

Overall adjusted net debt fell £1bn or 11% to £8.1bn partly due to proceeds from a partial listing of its European logistics operation which raised £395m.

In July, IMT agreed to purchase a number of brands from Reynolds USA for £4.2bn. The deal is expected to complete next Spring and will be financed by additional borrowing.

Alison Cooper, Chief Executive, said:
"This has been a year of significant delivery by Imperial. We've strengthened our brands and market footprint, improved cash conversion to 91%, reduced debt by £1 billion and delivered another 10 per cent dividend increase to shareholders.

We've achieved what we set out to achieve, creating a stronger business in the process. Trading conditions remain tough in many territories but the actions we've taken to enhance the quality and sustainability of the business have put us in a stronger position."

Dividend

Once again, they have not disappointed on shareholder return and have lifted the full-year dividend by 10% to 128.1p (2013 - 116.4p). There is a promise of a further 10%+ uplift for the coming year which would mean 141p for 2015. The results have been well received and in morning trade the share price was up over 2% at 2750p giving a yield of 4.6% and cover of 1.6x adjusted earnings of 203.4p.

The final dividend will be paid in February and will then be moving to quarterly dividends starting next June.

Given the decent share price appreciation over the past year combined with top ups to several of my investment trusts which have significant holdings of IMT, I am reaching a point where I will become too overweight with this share. I will therefore monitor and may sell if the price continues to rise over coming months.

Tesco - Interim Results

one of the few positive areas!

Just days before new boss Dave Lewis was called up a month early, the food retailer warned of a further slide in profits and slashed the dividend by three-quarters.

A couple of weeks later and news that Tesco had suspended four executives, including its UK managing director, after the supermarket overstated its half-year profit guidance by £250m. It launched an investigation headed by Deloitte.

During this turmoil, the share price has taken a pummelling, falling over 40% from £3.34 at the start of the year to well below £2.00 in September.

Today the company has issued its delayed interim results for the 6 months to end August 2014 (link via Investegate).

The headlines

• UK like-for-like sales down (4.6)%, impacted by strong competition across the grocery market, headwinds from price cuts and fewer untargeted promotions
• £0.9bn Group trading profit - year-on-year decline reflects challenges of UK business
• Total UK online sales up 11%; like-for-like sales growth of +0.8% in UK convenience stores
• Interim dividend 1.16p confirmed;  full-year capex reduction to £2.1bn
• New Executive team in place and reviewing all strategic options to create greater shareholder value

The Deloitte investigation into the validity of the figures has now concluded, and has confirmed  there was an overstatement in  profit expectations of £263m.  The impact to trading profit is £118m in the first half of this year, with a further c.£70m relating to the previous year and c.£75m relating to pre-2013/14 treated as one-off items within these results.

In addition, the chairman Sir Richard Broadbent has agreed to step down, which I think was inevitable given the record under his 3 year tenure of office. Just wondering what his pay-off package will amount to?

There was no hint of any decisions on the final dividend - I expect this will now come with the Q3 update in January - I am still hoping for something less severe than the 75% cut to the interim.

On the positive side, Tesco Bank's trading profit increased by 15.9% year-on-year to £102m, driven by strong lending growth.  Excluding fair value releases, trading profit grew by 18.8%. Tesco's UK online sales continue to increase as do sales from the smaller convenience stores.

Net debt increased by £500m year-on-year to £7.5bn.  This included the impact of the reduced level of operating cash flow and the investments in the China and India joint ventures.  The increase was partially offset by the disposal of China net debt and lower capital expenditure. The management have ruled out a rights issue to bolster the balance sheet so I imagine they must be looking to raise capital from disposals of non-core assets - maybe Dobbies garden center would be a good place to start?

All in all, a pretty gloomy picture and it looks like I was too hasty to jump in with my top up of shares last month. However the turnaround is underway and although there are sure to be a few more bumps along the road, I have every confidence the new CEO and his team can get things back on track. Sainsbury went through significant problems over a decade ago before finding stability again and restoring the dividend and shareholder value under Justin King.  

Tesco is still a very large business whose fortunes can and will be restored. At the time of posting, the shares are down 5% at 173p.

Once again, patience and a focus on the longer term outlook is the order of the day. More on this in early January.

Be interested to hear what others think of Tesco - feel free to leave a comment below.

GlaxoSmithKline - Q3 Results

GlaxoSmithKline is a large global healthcare company employing around 100,000 people in over 100 countries. It emerged in its present form in the year 2000 from a merger between Glaxo Wellcome and SmithKline Beecham.

GSK has today issued third quarter results (link via Investegate). Q3 sales and profits are lower as weak trading in the US and Europe overshadowed a strong performance in emerging markets. However, core earnings per share (excluding divestments) lifted 5% at constant exchange rates (CER) to 27.9p in the third quarter, but were down 2% to 68p in the nine months. Q3 revenues fell 3% at CER and 10% in total to £5.6bn and core operating profit dropped 1% CER and 6% in total to £1.9bn.

Pharma and vaccine sales fell 3% but emerging markets rose 12% and Japan was up 6%, offset by a 10% fall in the US and a 2% decline in Europe.

The shares have struggled this year falling from £16.15 in January to around £13.50 before today’s results. Over the past three months, GSK’s share price has slumped some 15% , compared with a 5% fall for the FTSE 100 over the same period. The business has been badly affected by allegations of bribery in China, requiring it to pay a fine of  $490m, as well as the expiry of some patents.

GSK said it was now targeting £1bn of annual cost savings over the next three years aimed at "refocusing" the business. It also said it would explore a possible flotation of ViiV Healthcare, a division focusing on treatment for HIV, to "enhance visibility within the group".

The firm also reiterated its financial outlook for the full year, saying core earnings would be "broadly similar to 2013".

GSK pays quarterly dividends. It declared a third interim dividend of 19p, unchanged from a year ago. The final dividend is expected to be 23p making a total for the year of 80p - an increase of 2.6% on the previous year. The company also announced that the 2015 dividend is expected to stay at the same level as this year. However, the good news is the announcement of a proposed return of £4bn to shareholders next year via a B share scheme - I calculate this to be worth around 82p per share. This is expected to conclude in the first half of 2015.

The results have been well received by the market and at the time of posting the share price is up around 3% to £13.85 and the current yield is 5.7%.

Investment Trust Income Outstrips Inflation

As most readers of this blog will know, I am a big fan of investment trusts when it comes to providing a steadily rising and predictable income.

It was therefore no surprise to read today’s article on the AIC website which shows that income from the average trust in the UK equity income sector over the past 20 years has outstripped inflation by over 2% per year.

This may not sound like much however when looking at the start figures for both income as well as capital, the comparison is compelling.

The data starts with a lump sum of £100,000 in 1994 - this was shortly before I bought my very first investment in City of London Trust. In year 1, it provided an income of £3,265, a yield of 3.26%. 20 years later and the income has risen to £8,139. The annual income grew by an average of 5% every year compared to an average inflation rate over the 20 yr period of 2.9%.

In addition to the total income generated over the period of £113,664, the capital value of the lump sum has risen from £100,000 to £222,315. Therefore a total return of over £235K and compound annual growth (CAGR) of 6.23%.

I have just made a quick calculation of the projected returns from my inv. trust income portfolio. Taking the round figure of £34,000 from the most recent update in August, and projecting forward 20 years with the same CAGR, if I have done the maths correctly, the value of the portfolio in 2034 would be just over £113K.

I regard my basket of investment trusts as the equivalent of an index-linked pension annuity with the advantage that, in addition to the growing income stream, I retain control of my capital which will give many more options in the years to come.

As ever, patience is the key....

Capita Dividend Monitor - Q3 2014

As an investor mainly focussed on dividend income, I like to keep up to date with UK market trends and statistics relating to dividends. The quarterly reports from Capita are an excellent resource.

Capita Dividend Monitor have recently issued their report for Q3 of 2014. The report compares dividends paid by UK companies and also looks at predictions for the full year.

Leaving aside the one-off effect of the Vodafone distribution earlier this year, headline dividends have advanced 6% including a number of special dividend payments, with underlying dividends ahead 3% year on year. As we know, dividends in the current climate have been held back by the strength of the USD v GBP. The pound has dropped 10c against the dollar over the past 3 months. Amongst the top payers for example, Astrazeneca and HSBC saw a 10% and 9% negative impact year on year respectively.

Dividends from companies outside the FTSE 100 have shown some promise this year. The smaller but faster growing constituents from the FTSE 250 increased payouts 7.6%. However, mid cap dividends only account for 9.3% of the UK's dividend total. The vast bulk of dividends are paid by the 'big guns' of the FTSE 100 - indeed, some 31% is paid by just FIVE companies.

(click to enlarge)

The forecast for the full year has been revised down from £101.8bn to £97.1bn (headline) The main reduction is a figure of £3.5bn being knocked off the previous forecast due to negative currency exchange rates. The underlying level is forecast at £79.3bn, 1.7% ahead of the previous year. The current forecast for 2015 is a lttle more promising with the prospect of an increase in underlying dividends of 5.5% to £83.7bn.

The prospective yield on all equities for 2014 has been reduced to 3.9% however they still remain the highest source of income across all main asset classes. The 10 yr benchmark for UK gilts is now down from 2.75% to 2.45%, property net of maintenance is 3.5% and instant access cash currently returns 1.5%

Although the rising value of the GBP is dampening down the dividend returns this year, it must be remembered that dividends have been bolstered by the falling pound since 2008 and this has been a benefit to UK shareholders. These things have  a way of balancing out over the longer term. I will be very happy if my dividend income rises 6% over the coming year and inflation remains at current levels of around 2%!

Volatile Markets

The markets all around the world have seen a sharp sell-off in recent weeks. At one point, the FTSE 100 was down around 10% on the past month before staging a recovery yesterday.

FTSE 100
(courtesy of Digital Look - click to enlarge)

Inevitably the media goes into predictable overdrive with warnings of crashes, and reminders of doom and carnage. For the average small investor, the combination of seeing your recently purchased portfolio of carefully selected investments lose 10% of their value in a matter of a couple of weeks together with media stories of more to come will create understandable anxiety.

Some newer entrants to the world of stocks & shares may have been lulled into a false sense of security over the past couple of years as the markets have been broadly rising and the wider economic news has been more positive. However, all investors know (or should know) that investments will rise and fall.

Anxiety can lead to uncertainty - as a species we are not very well equipped to deal with uncertainty, so I believe perhaps one solution to the problem of coming to terms with market volatility is to approach investing from a position of absolute certainty - markets will go up… and then go down. The other certainty is that no matter how far the markets fall, and then fall some more, in the long run they always bounce back.

The Income Investor

For me, the main reason for investing my money on the stockmarket is to secure a better inflation-proofed income than I could get from bonds and cash deposits. I don’t particularly relish market volatility but I am learning to take it in my stride a bit better than I did in the earlier years of my investing career.

For the day trader, share price/market volatility is where the action is and where quick profits are to be made (or lost!). For the income investor, falling markets will provide opportunities to secure a better yield but in general, so long as the dividends keep rolling in on a reasonably predictable basis and so long as those dividends keep increasing year-on-year a little ahead of inflation, I am happy.

The prices on my individual shares and investment trusts have mostly fallen by around 10% or so on average in recent weeks - some shares will have lost more than this, Hargreaves Lansdown, DS Smith for example. However, it looks as if my like-for-like projected dividend income for this year will have increased by around 8% compared to 2013. Of course, the current market volatility may continue for some time but at some point, maybe later this month/year, or sometime  next year, the markets will bounce back and normal service will be resumed.

Some media commentators equate volatility with risk. I think this is confusing two separate issues and tend to agree with Warren Buffett when he said “Risk comes from not knowing what you are doing”. This is not the same as the inevitable rise and fall of markets and share prices - it is what they do just as night follows day.

I read a piece in the Telegraph last week which ended with the words “Short-term volatility is the price that stock market investors pay for long-term out performance”. Not sure where the original quote comes from but just about sums it up for me.

Take it easy this weekend!

New City High Yield Results

NCYF has been a part of my SIPP portfolio for a number of years. It invests in high-yield fixed-interest securities and has produced positive NAV total returns and increased dividends in each of the past five years. The trust has a widely diversified portfolio, including some high-yielding convertibles and equities, with useful exposure to floating-rate notes to guard against inflation.

They have today issued full year results to 30th June 2014(link via Investegate)

Building on the previous years 7.4% uplift, the Company's net asset value has again seen an increase of 3.1% to 62.4p; when this capital measure is adjusted for the payment of dividends of 4.21p (4.1 p - 2013), the NAV total return was 10.3% ( 2013 - 14.9%). The share price total return was 13.7%.

Dividends have been increased by 2.6% to 4.21p giving a yield of  around 6.4% based on the current share price of 65.5p. The dividend is more than covered by earnings of 4.76p per share and revenue reserves are 136% - the equivalent of 16 months current dividends.

As in previous years, the trust continues to trade at a premium to net assets and the management have placed new shares earlier in the year raising £30m.  This has helped to increase the trusts market cap. to around £190m and also reduce the percentage of ongoing charges for the year from 1.18% to 1.12%. This reduction is, of course, as a percentage of net assets and in real terms, total expenses increased from £1.74m to £2.04m.

With a great deal of turbulence hitting the equity markets in recent weeks, it's reassuring to have the steadying effect of the fixed interest constituents in my portfolio.

As ever, slow and steady steps…

Portfolio Sector Weightings

I have not made a contribution to my basics section for quite a while - this is deliberate as I want to maintain a degree of simplicity. However, as I have been looking at the sector weighting of the various shares in my portfolio, I thought this subject may make a useful addition.

Shares are officially classified into 10 broad categories - Financials, Oil & Gas, Basic Materials, Consumer Services, Consumer Goods, Utilities, Healthcare, Telecoms, Industrials and Technology. These broad  industry categories are broken down into sectors and sub-sectors. Here’s a link to Wikipedia illustrating  how this all pans out

The current weighting for the FTSE All Share is set out in the pie chart

(click to enlarge)

The FTSE 100 is an index made up of 100 companies listed on the London Stock Exchange with the highest market capitalization. Taking the FTSE 100 as an example, the top 10 shares account for around 45% of the index's value. These same 10 names would account for just 10% of the value of an equal-weighted version of the FTSE 100. Similarly with the Euro Stoxx 50, the top ten shares account for almost 40% of the index value compared to 20% of an equal-weighted version.

Because a small number of very large companies dominate the index - Financials (HSBC, Lloyds Bank), Oil & Gas (BP, Shell) and Consumer Goods (tobacco shares, Unilever, Reckitt) are all 'overweight' -  it is inevitable that smaller companies represented in the other seven sectors are all 'underweight'.

The vast majority of trackers available to the average retail investor are cap-weighted. For much of the time, this probably does not make a difference, however at the time of the Macondo well disaster in 2010, BP’s market cap was nearly 10% of the FTSE 100 and when its share price fell 50%, it knocked 5% off the value of the FTSE.

Some suggest that because we cannot know which sectors will do well in the future and which will decline, it would be more sensible to operate an equal weighted index. Maybe this is more logical but such an approach would itself not be without drawbacks- for example, it can be argued it gives more prominence to smaller companies which can be more volatile and less resilient to difficult economic conditions compared to the larger companies.

A Look at a Couple of My ITs

Whilst investment managers and small investors in individual companies are of course free to choose the industries they invest in and the weight they give them, investors in trackers have to live with the sector skews of the index. Managers of active funds/trusts will have a plan of what weighting to hold in various sectors. By monitoring these weightings according to market conditions and making adjustments from time to time, they hope to gain an advantage for their investors.

 For example, in my holding of Edinburgh investment trust, the current weighting is Consumer Goods 22.1%, Financials 20.1%, Healthcare 20.0%, Industrials 16.7%, Consumer Services 6.3%, Utilities 6.3%, Telecoms 5.7% and Oil/Gas 2.8% - no weighting for Technology or Basic Materials (mostly miners).

The weighting by Nick Train at Finsbury Growth & Income trust is more focussed - Consumer Goods 38%, Consumer Services 28%, Financials 22% and Technology 11% with zero holdings in Basic Materials, Healthcare, Oil/Gas, Industrials, Telecoms and Utilities

With my own shares portfolio I favour Consumer Goods and Consumer Services which together amount to around 60% of my holdings - the only sector I do not hold is Telecoms. Here's how it pans out in my pie chart -

(click to enlarge)

Whether you choose active investing, passive trackers or a combination of the two, I think it is always a useful exercise to know what you are holding in your portfolio and how it combines to give a bigger picture.

If you keep track of your portfolio weighting and have a preference for some sectors over others, feel free to leave your thoughts/comments below.

easyJet - Pre Close Trading Statement

In a pre-close trading statement this morning, easyJet reported that profits for the second half have been revised up from between £545m and £570m to between £575m and £580m, after seeing around a 2% increase in revenue per seat and its unit fuel costs totalling around £2m in favourable terms compared to its previous expectations of an adverse £5m.

The group has also benefitted from the Air France pilots' strike in September, which is expected to increase EZJs revenue by around £5m.

Last month the company said it was also proposing to increase the proportion of its profits after tax paid in dividends from 33% to 40%.

CEO Carolyn McCall said: "easyJet has continued to execute its strategy, delivering another strong performance in the second half of the year. This has enabled easyJet to deliver record profits for the fourth year in a row.

We finished the year strongly. Our performance demonstrates our continued focus on cost and progress against all our strategic revenue priorities and further emphasises easyJet's structural advantage against both legacy and low-cost competition".

The budget airline anticipates that at current fuel and exchange rates, its unit fuel bill for the first six months of financial year 2015 is likely to decrease by around £20m compared to the half year ended 31 March 2014.

In addition, exchange rate movements are likely to have around a £10m favourable impact compared to the six month period.

The airline also posted its September passenger numbers, which showed a 7.5% increase in year-on-year passenger numbers.

The share price has seen quite a dip in recent months falling from a high point of £18 in April to below £12.50 in August. This mornings news has provided a boost and at the time of posting, the sp is up 6% at £14.55.

courtesy of Digital Look (click to enlarge)

Last year the full year dividend was 33.5p plus a special dividend of 44.1p - I’m not sure whether they will repeat the special this year but have pencilled in a figure of 45p for the final which would give a fwd yield of 3.1%.

More on this following the final results on 18th November.

Tesco - Top-Up decision

Its less than a month since the last post relating to a cut in the interim dividend.

This week we have seen further bad news relating to an over-statement of profits to the tune of £250m and some irregularities in the accounting process. Some senior executives have been suspended pending the outcome of an investigation. This has knocked the share price below 200p and has brought forward the start date for the new finance director.

The half year results have been delayed until this mess can be investigated. How the mighty are fallen! I wonder what Jack Cohen would make of the current state of affairs.

Some Positives

Reading some of the media headlines this past few days, you might think Tesco was on the verge of a collapse. The reality is that they are still likely to deliver profits of around £2bn in the current year. Yes, their share of the market has fallen over the past couple of years but they are still by far the largest supermarket in the UK with a market share of around 28%.

Whilst most of the profits are made in the UK, lets also not forget that Tesco is a global player. It has operations in many countries in Europe, further afield, Thailand, S. Korea, and Malaysia as well as joint ventures in India and China. These markets offer massive growth potential for the future. Of course, there have been set-backs in USA and Japan and I believe they may well have learned a few good lessons.

The company has large property assets - I believe at the last valuation they were said to be worth around 220p per share, that’s more than the current price of the whole business!

Another plus is the appointment of new people at the very top. New CEO Dave Lewis has 30 years retail experience with Unilever and new finance director Alan Stewart who now starts 2 months earlier than planned, comes highly respected from M&S.

Decision made…

1 yr chart TSCO/SBRY
(courtesy of Digital Look - click to enlarge)

At the start of the year the share price was 334p. A month back, the price had fallen back to around 230p and I was undecided whether to sell out, stick or buy more - I decided to hold on and wait to see the announcement of the final dividend. At the same time, I placed an alert to be notified if the share price fell below 200p - at which point I thought a top up would be tempting. I never imagined it would happen so quickly however the alert was triggered yesterday. 

There is some uncertainty on the future level of the dividend. We know the interim will likely be slashed by 75% to 1.16p. If the final dividend was cut by a similar amount this would make 3.69p for the year however I am hopeful the cut to the final will be less severe and the full year amount could be around 7.0p. Earning are forecast to be around 22.0p - a reduction of 30% on the previous year.

I believe the ship will be steadied and I am sure the fortunes can be turned around over the coming year or two. Although it may well be wise to await the outcome of the interim results - now due 23rd October, I have decided to throw caution to the wind and top up my holding. The holding is topped up at 193p.

I have also decided to double up on my holding with Sainsbury as the share price has been adversely affected by poor sentiment for the sector. The purchase price is 260p and yield over 6%.

As Oscar Wilde said “I can resist everything apart from temptation” - would someone pass me my tin hat….

All thoughts/views on the supermarket situation welcome...feel free to comment below.