In this month’s Dividend Hunter column for Master Investor magazine I looked at some of the highest yielding stocks in the FTSE All-Share.
Not to buy them of course, because the dividend yield on its own is a crude tool at the best of times.
Instead, I was interested in finding out which companies have crashed and burned and what lessons can be extracted (for free) from their mostly unhappy situations.
One major recurring theme was an excessive use of debt, which afflicts all but one of these companies.
And the one company that doesn’t have excessive amounts of debt? It might actually be a bargain:
Unearthing bargains among high yield stocks
John, Interesting points on Connect Group — are you OK with investing in companies with operating margins down at 2+%?
My main concern with this is the sheer scale of the operation to generate a small relative return on such a high turnover.
Over the last 5 years the turnover has been between £1.8-1.9bn and an average £42M profit — it’s also very manpower intensive — isn’t it therefore subject to the pending wage inflation, without the ability to raise prices?
The last 5 years seem to have been stable, and so might the next, but the slim margins don’t leave a lot of room for error I assume?
On another point, is it sensible to be paying a dividend up at this level, on such a tight business?
In a similar manner that management at the likes of Carillion and Balfour Beatty paid scant regard for risk, could the same not be said for Connect’s management for not exercising prudence on the pay out?
John Kingham says
Hi LR, I look at return on capital employed (ROCE) rather than profit margins to measure profitability, so yes, I’m comfortable with low margin businesses as long as their ROCE is reasonable.
It does therefore require a lot of sales to generate a relatively small profit, but I don’t necessarily see that as a problem.
“isn’t it therefore subject to the pending wage inflation, without the ability to raise prices?”
Possibly, but again, not necessarily. If it has more efficient operations than its competitors, which it may have due to its dominant scale in its core newspaper/magazine market, then rising input costs may lead competitors to fall over first, leading to increased market share for Connect. Whether that happens or not I obviously don’t know, but rising costs are not always bad, especially if you’re the lowest cost provider.
“is it sensible to be paying a dividend up at this level, on such a tight business?”
I think it’s likely that there may be (or perhaps should be) a dividend cut because of the sale of the education business. However, I don’t see any obvious reason why it would be more than 50%, or even that much. The dividend yield is currently almost 10%, so even a 50% decline in the dividend would leave Connect with a relatively attractive 5% yield.
Anyway, its annual results come out very soon so we’ll soon have a better idea of what’s going on, and I prefer to buy when the annual results are relatively fresh.
Steve Kirk says
Interserve is my biggest investment disaster to date and a stark warning that past performance, even over many years, is no guarantee to future success. I bought in 2015 at £6.18 and it’s been a horror show ever since. At first, it seemed like a temporary blip and I bought again in 2016 at £4.18, when the shares appeared cheap in the expectation of a recovery in 1-2 years but instead the company has fallen apart and the share price has slide down ever since. Although it’s never been more than 5% of my portfolio, it’s still a drag on overall performance.
Looking at my notes, in 2016 the PE was 6.5,yield was 5.8% and earnings were forecast to be flat in 2016 and growing in 2017 so it seemed a reasonable assumption that the good times would return but as it has turned out, the disastrous EfW contracts have really killed the company.
I think anyone who spotted that coming before the first profit warning, would have to be a very astute stock analyst so I’m not beating myself up about that too much. But what I have learnt from this sorry story is the need for a ‘margin of safety’ in terms of debt and other liabilities, even for historically successful companies and for the need to watch for any changes whenever financial statements and updates are published. Whether I’d have the self belief to sell even if I’d spotted the debt and pension issues is another question
John Kingham says
Hi Steve, bad investments happen to the best investors, so you’re right to not beat yourself up too much about it.
“what I have learnt from this sorry story is the need for a ‘margin of safety’ in terms of debt and other liabilities, even for historically successful companies”
Yes, a prudent debt profile is absolutely critical. Past success over many years is one thing, but companies change, their strategies change and their CEOs change. What was once a low risk, well-managed company can quickly become an overly ambitious, overly acquisitive and overly indebted company.
And that leads into your second lesson:
“the need to watch for any changes whenever financial statements and updates are published”
This is an absolute must. Companies and the economy are dynamic systems, not static, so reading the latest annual and interim results when they’re published is a bare minimum. And rather than just reading them, investors should re-analyse the investment case in light of the new results.
Having said that, like you I don’t automatically sell companies when they become over indebted. Unfortunately it’s impossible to know if an over indebted company is about to tank, and not all of them do. Usually I just find it mildly annoying, although it does make it more likely that I’ll sell a company if it becomes one of weakest holdings in my portfolio, in terms of income, growth, quality, etc.
I guess one positive point is that you were sensible enough to have only 5% invested in Interserve. I certainly don’t trust my own judgement to have much more than that in any one company, and I think 5% is a reasonable upper limit for most investors.
Steve Kirk says
Thanks for the reply, John
Just by co-incidence there was a very good commentary in the Sunday Times business section today about Interserve and their fall from grace that I’d recommend reading if you’ve not already seen it. They blamed the acquisition of Initial in 2011 (I think) as the root cause of their debt and operational problems which highlights one of your other rules about avoiding over-aggressive acquisitions.
John Kingham says
I haven’t seen it but by the sound of it I’d completely agree with their premise.
Certainly getting cheaper today as it’s just dropped through it’s 52 week low — yield over 10%.
Maybe somebody knows something that’s not immediately on the surface here?
The stock seems to have dropped every month since January — trend seems inexorably down. One to keep the powder dry on for the moment John.
Incidentally – where is IG group and Rio Tinto on the old stock creen list these days – both seem to have recovered – massively so in RIO’s case which I offloaded this week – IG still looks like a buy based on all your sound arguments in your last fine article (unfortunately time as it happened – still that’s markets for you).
John Kingham says
Could be. Perhaps the dividend is about to be cut, but even if it were slashed in half the yield would still be 5%. The annual results are out in two days so we’ll know then. As for:
IG Group – It’s still one of the highest ranking stocks on my stock screen, so I have no plans to sell.
Rio Tinto – This one is nudging towards the exit, largely because of the share price increase but also because of its weak results following the commodity crash. This one is a bit like Braemar Shipping, where I now know to only pay rock-bottom prices for highly cyclical companies.
Well I have to hold my hands up and did revise my overly cynical view on IG and took the plunge when it tanked and bought more on the way up. Potentially, and subject to kind regulatory reviews, it seemingly has further to go. Some of my RIO money will go into this I think to take it from 2.5% to 3% of my shrunken wad.
Ummmm – There is definitely a skeleton in the cupboard here somewhere – the stock dropped another 4+% this morning to 89.