Creaming off the dividends

The market may turn from bullish to bearish, but high-yield stock can cushion you from its vagaries.

"BACK TO BASICS" was the slogan of a dying Conservative government, and it could yet be the cry from a dying bull-market. Share prices have risen dramatically - with the FTSE 100 rising by 25 per cent in the last year - and a fall may be in the pipeline, but going back to the basics of shares may save investors from the worst of a drop in the market.

The most basic aspect of a share is its dividend - an amount paid to shareholders, usually twice yearly, by companies - and with the high prices in the stock market at the moment, this should be to the fore in investors' minds.

In recent years, yields have fallen to lower and lower levels as share prices have come to be seen as the major determinant of where markets are moving. Yet they remain important - and not just as a source of income. They are a means of investing "defensively" at a time when there are mounting suspicions that the markets' bull run has stalled.

Not only are dividends one way to profit from shares, since they are paid to shareholders, but expectations of future dividends determine the prices of shares in the market.

Dividends are usually expressed in terms of dividend yields, or just "yield" as it is listed on the share pages of newspapers, including The Independent. This is the annual dividend per share divided by the market price of the share. So if a share with a price of pounds 1 has a yield of 5 per cent, the dividend is 5 pence per year.

Yield is important at present because shares with high yields may be affected less by a fall in the market. This will have implications for a portfolio or any investment plans, especially if one wants to invest defensively, having some exposure to the market but suffering less in the event of a fall.

As Matthew Orr, a partner at stockbrokers Killik & Co, says: "If you've got a company that is going to offer you a quality 8 per cent yield then even if the market were to come back down, 8 per cent is always going to be an attractive income to get on your money.

"There will be buyers around who just say, `Well OK, I'm happy to keep the shares because even if I just get 8 per cent on my money and my capital goes nowhere, I'm still getting a reasonably good return. Equally, if the market does turn around, then I've got my toe in so that when it rises on the next upturn, I can enjoy part of the upswing".

The important point here is Mr Orr's insistence on "quality yield", by which he means yield that is unlikely to fall. High yield as an indicator is not enough on its own - you need high yield you can depend on.

"There is a defence in high yield shares, provided the company behind them has a strong balance sheet, so that the dividend is well covered by earnings and is secure. Then I think that if you have a high yield, it does act as a defence," explains Michael MacDougall, associate director of Norwich and Peterborough Building Society's stockbroking arm, Waters Lunniss.

Investors need to be wary of two potential problems with high yield shares. Firstly, high yield now may encourage some companies to offer lower yield in the future. A company may have high dividends, and therefore high yield, and use this to justify a cut in dividends leaving you without the return you anticipated.

Secondly, if a stock market fall results from recession, and most expect it will, then a company's profits will be hit and this may reduce dividends. This effect will vary from company to company, but it is an important factor.

What investors should be on the lookout for are so-called "income shares". Utilities provide a good example: their share prices reflect their dividends now rather than high expectations of future growth - hence their high yield - plus the fact that there will be demand for their services even in recession.

They are also mature stocks, with a good track record in paying high dividends. Therefore, they provide relatively reliable income and are likely to suffer less in a stock market fall. They will still produce a healthy dividend.

The attractiveness of income shares is enhanced by the fact that many of them have not risen too much in the recent bull market. "Income shares generally didn't perform particularly well last year, and didn't get overblown," adds Mr MacDougall.

However, deciding which high-yield shares are dependable and attractive is not always easy. The Independent asked a selection of stockbrokers to name their preferred choices. All of their suggestions offer yield above the FT Actuaries All-Share yield of 2.88 per cent at the time of writing - although the high level of the market means that yields may not all be as high as in the past.

Investors with smaller sums of money, under pounds 50,000 say, may also want to consider high-income unit trusts - they invest in these kinds of shares as well as other income-generating investments, such as bonds.

However, stockbrokers point out that for the really risk-averse, cash and bonds are still the preferred option.

Aim For A `Hefty Yield'

ANTHEA GAUKROGER

Associate director Greig Middleton

United Utilities: yield 6.4 per cent. Boardroom problems at this water and electricity supplier, with growing interests in telecoms, have been overcome and new management is aiming for strong rises in real dividends.

Anglian Water: yield 6.0 per cent. Some of the best standards (lowest leakage rates) in the water industry, combined with cost-cutting suggest further dividend growth is expected

Land Securities: yield 3.8 per cent. The UK's largest quoted property company, specialising in the ownership and development of out-of-town retail food superstores, industrial and warehouse properties, it looks set to enjoy rising rents and growth in net asset value.

British Telecom: yield 3.1 per cent. Still the dominant supplier of telecoms despite competition, BT is well placed to benefit from newly liberalised continental markets, and is engaged in a number of joint ventures, although it appears to have been left at the altar by a number of potential suitors.

Commercial General Union: yield 3.0 per cent. The newly-merged life and general insurance group, formerly General Accident and Commercial Union, is aiming for cost savings of pounds 225m in the next two years. Life insurance business is moving ahead, although competition continues in the merged group's general insurance business, and problems with subsidence and storms continue.

MICHAEL MACDOUGALL Associate director Waters Lunniss

Framlington Income and Capital Investment Trust: yield 9.9 per cent. Locking into this high yield for a five-year period looks attractive and the manager of the trust adopts a low-risk strategy.

British Steel: yield 9.8 per cent. The shares look excellent value. Last year the strong pound cost British Steel pounds 500m in profits which were also hit by recession in Asia. Despite its recent strength, I believe sterling is set to ease steadily in the next few years as we move towards a single currency, creating fresh opportunities for British Steel.

Invesco Geared Opportunities Trust "INGOT": yield 9.3 per cent. Geared Ordinary Shares in this trust deliver a hefty yield, and while this trust was only launched recently, increasing risk slightly, it looks promising at present.

AG Holdings: yield 8.8 per cent. A small company, but Europe's largest manufacturer of reels for cables, from the larger ones supplied to cable and wire rope manufacturers to collapsible reels for the French market. Financially strong and the shares are trading at a significant discount to both the sector and market average.

M&G Income Investment Trust Geared Units: yield 7.8 per cent. The trust has a life of under four years and only needs 2.8 per cent growth to protect your investment. Past performance suggests it will exceed this.

Brokers' Advice: `Go For Dividend Growth Potential'

JEREMY BATSTONE

Head of research NatWest Stockbrokers

Southern Electric: yield 5.7 per cent. Strong balance sheet and an annual dividend growth target of 5-8 per cent in real terms offers scope for good returns. It is also a takeover candidate. The group seems reasonably well placed ahead of the next regulatory review in 2000.

Scottish Power: yield 4.8 per cent. Scottish should have a lower proportion of profits from regulated activities and should offer continued good dividend growth potential.

P&O: yield 4.6 per cent. Continuing to benefit from the strategy outlined in the 1996 re-focussing programme, involving property disposals and joint ventures to reduce exposure to difficult markets. The shares stand on a sub-market PE ratio as well as offering premium yield.

Merchant's Trust: yield 4.4 per cent. This UK Income Growth Trust has proved popular with investors seeking a safe haven from sterling's ongoing strength and its adverse consequences for companies with overseas earnings.

REXAM: yield 3.8 per cent. A new management team has been repositioning and rationalising this group of packaging and printing companies. Its key markets are still awaiting upturn.

MATTHEW ORR

Partner Killik and Co

Carpetright: yield 10.2 per cent. Selling carpet and floor coverings. The Harris family, which includes Lord Harris, the chairman, recently bought a significant number of shares.

Lambert Fenchurch: yield 6.8 per cent. Leading insurance broker forecasting modest increase in profits for the forthcoming year. Recent ventures in Germany and the United States are being formed with strong overseas partners.

United Assurance: yield 4.8 per cent. A new chairman and chief executive look likely to awaken the potential in this large insurance group, which has hitherto specialised in traditional door-to-door sales of policies to less affluent clients.

Rio Tinto: yield 4.6 per cent. The largest mining company in the world. Recent weakness provides a buying opportunity for longer-term investors.

Williams Holdings: yield 4.1 per cent. Owning Yale and Chubb, two major locksmith companies in the UK. This group looks set to benefit from growth in the fire protection and security systems markets, both for domestic and commercial properties.

ALLAN COLLINS

Partner Redmayne Bentley

Carpetright: yield 10.2 per cent. Profit warnings have dragged the share price down, but directors have been buying shares. A speculative recovery stock.

Billiton: yield 5.2 per cent. This is a property investment and development, building and civil engineering company, also engaged in contracting, housebuilding and plant hire. It is a small-cap company whose shares have almost halved in price on the back of weak metal prices, so good value.

HSBC: yield 4.3 per cent. One of the largest banks in the world, owns Midland Bank in the UK. Has become a casualty of the Asian crisis, but strong enough to to emerge as a long-term beneficiary of weaker banks' vulnerability.

Next: yield 4.3 per cent. The shares of this clothes and mail-order furnishing retailing store have fallen recently but directors have been buying. A fallen star which should regain its former glamour.

PowerGen: yield 4.4 per cent. Good dividend growth of this electricity and gas company, with a range of international operations, is projected and a strong balance sheet may lead to acquisitions or a possible tie- up with a US company.