Diary: Dividend growth

An article at Dividend Growth Stocks got me to thinking about using dividend growth as a filter for investing. The aim would be to try to pick out low risk, high quality companies obtainable at a reasonable price. An investor could look at the current debt situation, and factor in some light-weight qualitative factors. By "reasonable price", I mean anything below 16X PER. It's not a cigar-butt technique; think Marks & Sparks, not Primark.

I just picked out a few examples off of the top of my head (I own all of them except Tescos), and compiled the following table:

     CDR   SPR

DNO  18% +483% Domino Printing Sciences

SN.   9%  +49% Smith & Nephew

BATS 16% +415% Brit Amer Tobacco

BLT  27% +534% BHP Billiton

VOD  24%  -10% Vodafone

Legend:

CDR: Annual Compound Dividend Rate over last decade

SPR: Share Price Return over last decade

All of the shares listed have had increasing dividends for the last decade; some of them spectacularly so. BLT increased its dividends a massive 27% pa for the last decade, which is truly staggering. The performance of the share prices was very good, too, averaging +255% over the decade - that's about 14% pa. By contrast, the FTSE returned 4% pa. all of them beat the FTSE, except VOD. They had a 7:8 share split in 2006, for which I'm too lazy to adjust the dividends for. Also, its share price plunged precipitously during 2002, which is what I think at a very high PER at the beginning. So a sensible investor would have been able to avoid VOD shares.

This is, of course, hindsight bias (except the VOD thing - a lot of tech stocks at ridiculous multiples could have easily be avoided by those with just a modicum of investment skill). We of course know what you should have done: buy companies that will increase their dividends steadily over the next decade. They'll likely do fantastically well. Ah, but which ones will they be?

I think this is where the "light-weight qualitative factors" comes in. You're looking at the historical record and asking yourself if it's likely to continue. You might look at BLT, and conclude that seeings as it's a commodity company, the future is too unpredictable, and you should avoid.

But there are other candidates, like BATS, which seems in a pretty stable industry. Analysts expect EPS to grow 12% in 2011, and a further 9% in 2012. It currently yields 4.4%, and is on a PER of 14.9. z-score is over 3, so that's pretty good. I look at it this way: I can probably get a better than 10% total return for this stock over the next year. Considering that the market has been flat for the last decade, that's a pretty good return. And remember, you're getting this with minimal risk.

If you look at VOD, analysts are expecting a whopping 31% increase in dividends in 2012 - although that is exceptional, of course. VOD trades at a PER of 11.4, and a PBV of 1.1. It seems to be doing OK in new markets, too. Probably not a choice that will astound Buffett with the depth of your insight into the company, but it looks like it will spit out the goods. Divvies have been growing at only 7% pa over the last 5 years, so it's probably entering a slower phase than in the early 2000's. Like I say, there's nothing I consider inspired about the pick, other than the fact that investors will probably do OK.

DNO looks pretty good on paper. It makes industrial printers - for stuff like printing expiry dates on food products, printing on eggs (no joke!) and printing despatch labels for packages. It's on a PER of 14.5, has a market cap of nearly £600m, and has net cash of £12m, and negative gearing. Interest cover is 201, z-score is 5.98, so the balance sheet is clearly very solid indeed. Its ROE is 21%, compared with a decade mean of 19%. It wins design awards. I like the fact that it has a very nice cash position, and is small enough that there's plenty of room for expansion.


I reckon that if an investor can put together about a dozen issues like DNO, and is patient, they'll do well. Not "Buffett well", but "market beating" well. Some of them will be duds, of course, as no-one can predict the future. There's a poster I respect who found good results over the last decade by buying good-quality low-risk companies at reasonable prices. It seems that the market tends to overlook them in favour of cheap junk or overpriced high-growth shares (some of which turn out to be junk in the end, anyway). BATS is up 19% YTD, compared with FTSE down 6% - a comparison that you are no doubt tired of. I like making that comparison because it just goes to show how a boring, non-esoteric, reasonably priced good-quality company can slaughter the index. That's a serious out-performance. Admittedly, we may be having market conditions that are conducive to such outperformance; but it still makes me think.

Diary: Peter Lynch, csinvesting, HIK

Peter Lynch
Here's an article in Yahoo Finance, which was originally published on Stockopedia, which advertises their screener. They put together the following criteria to emulate Lynch growth:

• Annual EPS Growth Rate >= 15% but <= 30%.
• PEG < 1.0
• Institutional ownership <50%
• Total Debt / Total Equity < 25%
• .Market cap less than $2 billion
• Operating Margin 5-Year Average >= 50% * Current Operating Margin. This is an attempt to screen for consistency of earnings, although this is difficult to do so effectively. One should ideally study the pattern of earnings, especially how they reacted during a recession
• Price-Earnings: The price-earnings ratio is less than the industry's median price-earnings ratio and less than the five-year average price-earnings ratio. Finding a good company is only half the battle in making a successful investment. Buying at a reasonable price is the other half
• No Financials

Lynch warns against:

• Hot stocks in hot industries
• Companies (particularly small firms) with big plans that have not yet been proven
• Profitable companies engaged in diversifying acquisitions. Lynch terms these "diworseifications."
• Companies in which one customer accounts for 25% to 50% of their sales

 One micro-warning signal, particularly important for cyclicals (manufacturers & retailers) is if inventories that are building up. If they are growing faster than sales, that is seen as a red flag. On the other hand, if a company is depressed, the first evidence of a turnaround is when inventories start to be depleted.

There is also a link to a discussion of growth investing on Stockopedia.

Blog: csinvesting
I just discovered a value-investing blog, csinvesting, which has some interesting content. Check it out.

HIK: Hikma Pharmaceuticals - Pharma & Biotech - 636.3p/£1.2bn
I was on the lookout for a growth company, and came across this stock. HIK is a pharmaceuticals company, with three segements: branded, injectable, and generic. It's on a PER of 18.97, so scrapes through as a GARP. Gearing is 41%, and interest cover is 10.6. It has net debt of £196m. I was going to write that off as an "immediate fail", but I think things aren't so bad. Net profit for last year was 61m, add back exceptionals of 3m, and you get an adjusted net profit of 64m. So it could pay off its debt in 3 years (196/64). It's median PER since flotation in 2005 is 18.7 - so it's about in-line. Revenue growth has been about 30% pa over the last 5 years, whilst operating profits have grown at a rate of about 24% pa. 5-year EPS growth is about 20%. Directors own about 30m worth of shares, which is a reasonably chunky amount. Median ROE over the last 5 years was 12%, which is a bit disappointing. I'd hope for 15%. Median 5-year operating margins were 19.6%, which look uninspired against AZN (Astrazeneca), which has a margin of 31%, and GSK (Glaxosmithkline)  of 34%. Take a look at the interview with CEO Said Darwazah for a run-down on the results for 2010. Motley Fool also wrote an article about it in August 2011. I can see the attraction in it, and I wouldn't necessarily rule it out as a GARP share. It doesn't seem to get much of a following on the boards. Perhaps one to keep on a watch list. If I had a choice, I'd rather have my CTN shares (I'm taking price into consideration).

Growth opportunities
My shares in IQE have been rocketing lately. I bought at the end of September, and have seen them go up 20% in the space of a little over 2 weeks. If only they all did that! It just goes to show that you can get some good things happen to you in depressed markets if you spot some companies with good growth opportunities. Much more exciting than owning those boring go-nowhere companies! IQE currently trades on a PER of 18.8, so I wont be looking to add more at these prices. This one to look out for dips. IQE hasn't been much of a victory for me, you should understand, because it only makes up 0.7% of my portfolio. I was waiting for my CTN money to come through, and anticipating further drops in the market.

I think there are some cracking growth companies still worth buying in the current markets. One is PTEC (Playtech), that provides software to online gaming companies. It's on a PER of 7.6, has ROE of 29%, and oodles of cash. Another one is PIC (Pace), the set-top box maker. It's on a PER of 4.4, has a ROE of 29%, although admittedly the debt situation is not good. Prospects do seem good, though. I also think SBT (Sporting Bet) offers very good value at a PER of 6.5, high ROE, and plenty of cash. I think it's important not to over-concentrate in a sector - especially in online gaming, which is one with many uncertainties surrounding it. If you're willing to cough up a little more, and go where there isn't as much growth, but still above-average growth, then I think there's quite a lot of opportunities: SN. (Smith & Nephew), BATS (Brit American Tobacco), MRW (Morrisons), DNO (Domino Printing Sciences), and I'm sure many many others that you could come up with that I had never even heard about.