MIDAS STOCK TIPS: Dividend powerhouses to generate income

In 1991, a 44-year-old American financier published a stock-picking theory that caught the attention of investors around the world.

His name was Michael B. O’Higgins and his Dogs of the Dow idea was simple: invest in the ten highest paying stocks in the US Dow index, check that your portfolio is up to date every year and you should end up with stocks that pay generous dividends and also increase in price over time.

Midas picked up the theme 20 years ago and we’ve revisited it from time to time ever since. Instead of picking Dow stocks, however, we focus on the FTSE100 index, which includes Britain’s largest listed companies. Over the past two decades, the Dogs of the Footsie have occasionally stumbled, with stock prices falling from period to period. But they have undoubtedly generated consistently high dividend yields, which has been particularly important in recent years when savings rates were at their lowest.

Solid foundations: Over the past two decades, the Dogs of the Footsie have occasionally stumbled, but they have undoubtedly produced consistently high dividend yields

When Midas last watched the Dogs, it was in the summer of 2020. The UK had come out of lockdown, the stock market was starting to recover from spring lows and businesses were starting to feel more confident.

At the time, our ten dogs were dominated by financial firms – M&G, Aviva, Standard Life Aberdeen, Legal & General and Phoenix Group. Cigarette makers Imperial Brands and BAT were also on the list, along with Vodafone, BP and Russian steelmaker Evraz. Yields ranged from Imperial at 11% to Phoenix at 6.5% and the average across the ten was 7.75%.

Today, the picture is quite different. M&G, Aviva and Phoenix are still in the pack, as is Abrdn, formerly Standard Life Aberdeen. But they are joined by a trio of homebuilders, Persimmon, Barratt Developments and Taylor Wimpey, as well as insurer Admiral Group and mining giants, Rio Tinto and Glencore.

Notably, yields have soared. Rio Tinto produces an extraordinary yield of 14%, the average yield is over 9.5% and even the lowest producer, Admiral, offers a high yield of 7.7%.

What is behind the sharp increase in payments?

Dividend yields are simple to calculate. All you have to do is divide the next scheduled dividend by the stock price and turn it into a percentage. Normally, very high returns occur for one of three reasons. Sometimes stocks have recently fallen in value, and as they fall, the yield rises. Sometimes high yields are a clue that market watchers think the expected dividends are unrealistic and likely to be cut. And sometimes high returns happen because companies have a lot of money on their balance sheet and want to reward shareholders.

This summer, all three reasons have a role to play.

Take home builders. Khaki is down more than 35% in the past 12 months, while Barratt is down nearly a third and Taylor Wimpey is 27% lower than last summer. But all three are expected to increase or at least maintain their dividends this year, so Persimmon returns over 12%, Taylor Wimpey hovers around 8.5% and Barratt isn’t far behind.

The sharp declines in the stock price reflect widespread fears that the housing market is headed for a tumble. Still, homebuilders remain confident and the real estate market is very different from what it was during the last recession in 2008. Not only had prices risen much faster then, but banks were granting mortgages to virtually anyone who wanted one. According to a report, half of mortgages in 2007 were signed without the potential owners needing to provide any proof of income. Today, this figure is estimated at 0.3%. Many mortgages these days are also fixed rate, so they are not exposed to rising interest rates at this time.

It’s also important to note that homebuilders are much stronger financially than last time around, so they’re less likely to panic if the market gets tough. And demand is expected to continue as the UK desperately needs more housing.

All of this may mean that recent stock price falls are overblown and dividend payouts are less vulnerable than pessimists believe.

Veteran analyst Charlie Campbell of brokerage Liberum suggests that our trio of house-building dogs will at least maintain their dividends and should slowly increase them over time.

So could these healthy dividends be here to stay?

Rio Tinto’s performance also soared as its share price tumbled. At the start of 2021 Rio shares were above £65 and even in January this year the price was flirting with £60. Today, the stock is below £50, bringing the yield to 14%.

Rio Tinto is one of the largest mining companies in the world, with a particular focus on iron ore, aluminum and copper. These commodities jumped in value last year, but have fallen sharply in recent weeks amid growing fears of a looming global recession and a consequent slump in demand for industrial metals. There is no doubt that Rio’s revenues will be affected if business activity slows and analysts anticipate a lower dividend in 2023 than they do this year. However, the company has a stated policy of paying decent dividends and the long-term outlook is bright.

Countries around the world have pledged to spend money on infrastructure, which means the longer-term trend is that demand for the metal is likely to increase. The transition from fossil fuels to renewables also requires huge amounts of metal, for everything from wind turbines to electric car batteries. Still, supplies are tight as miners have been careful not to spend too much on exploration in recent years. This suggests that metal prices should hold up over the next decade, even if they suffer in the short term.

The same logic applies to Glencore even though it is quite different from Rio – and most other miners as well. The group is the world’s largest producer of maritime coal, which has come back into vogue since the invasion of Ukraine prompted governments to seek alternatives to Russian oil and gas. Glencore also has a large marketing arm, shipping metals around the world, not only from its own stock but also from other companies. And it can boast of having a green angle, despite its coal activity.

The group is a key producer of metals such as copper and zinc and is also important in cobalt, which is a key constituent of lithium-ion batteries. To further bolster these environmental credentials, Glencore runs a major recycling business, recovering scrap metal from major manufacturers and turning it into usable material.

Overall, analysts are much more optimistic about this company than most of its peers. The stock is yielding more than 9%, reflecting optimism about this year’s dividend, but the shares are also in a good position, having risen more than 40% since last summer.

HOW WE CHOOSE THE TOP TEN TIPS

The Midas Dogs of the Footsie portfolio tracks the ten best performing stocks in the FTSE100 index.

Midas regularly re-evaluates the portfolio, removing stocks that are no longer the best performers and replacing them with those that are, at the same value.

In this column, our calculations are based on share price only, so we do not include dividends received by investors.

Their addition clearly increases overall yields.

Our financial dogs are faring much worse. When fears about economic growth hit the market, companies involved in managing people’s money are invariably caught in the turmoil. So it’s proven this time. Abrdn shares were the hardest hit, but M&G also suffered. Both stocks were already very productive two years ago. They always are. But their dividends could be at risk if stock markets take a serious dip in the coming months.

Looking back, the stock market has been on something of a rollercoaster since the coronavirus swept the world. At the start of 2020, the FTSE100 index was around 7500. It dipped in the spring and was at 6090 when Midas last watched the Dogs. The index then rallied, but a choppy few weeks took its toll and the index closed last week at just over 7200.

The fall in confidence has not left our dogs immune. We invested a nominal amount of £10,000 in our dog portfolio in 2012. A decade later the shares are worth £13,003. It’s far from a stellar performance, but if that same £10,000 had been invested in the FTSE100, it would be worth just £11,922 today. Additionally, investors have been rewarded with consistent dividends for most of this time. And if they reinvested those dividends every year, the returns would be significantly higher. It’s not hard to see why O’Higgins’ theory remains attractive more than 30 years after he first launched it to the world.

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