Dividend Yield (DY)

The dividend yield is an important investment tool. There is very strong evidence to support the argument that high-yield portfolios outperform the market as a whole:-

1. During the 20 years from 1977 to 1997, £1000 invested in the average UK Growth unit trust, with dividends reinvested, grew to £18,184; in the UK Growth & Income sector the comparable figure improved to £20,343 and in Equity Income to £20,572. The best growth fund grew to £33,829, the best growth & income fund to £33,609 and the best income fund to £33,646 (figures by Micropal).
2. Michael O'Higgins' book, Beating the Dow, clearly demonstrates that, on a total return basis, high yielding stocks beat the American market as a whole. One of O'Higgins' systems simply selects the ten highest-yielding Dow stocks. At the end of each year he repeats the whole exercise again, selling those companies that no longer measure up and replacing them with new high-yielders.

O'Higgins' statistics show that, by following this system over a period of 18 1/2 years from 1973 to 1991, an investor would have enjoyed an average annual gain of 16.61% compared with only 10.43% on the Dow. The ten stock portfolio outperformed the Dow 13 times out of 19. After adding dividends received, but with no charge for commissions, the cumulative gain
before tax was more than 1750% against only 560% on the Dow.

One reason high-yielding shares outperform the market on a total return basis is that they are usually companies that are out of favour. The stockmarket over-reacts to good and bad news, often driving up the prices of growth shares to dizzy heights and leaving less popular (and
apparently more risky) stocks to languish at bargain levels. In essence, therefore, buying high-yielding shares contains a strong element of contrary thinking.

Another reason high-yielding shares do well is advanced by O'Higgins. He points out that, historically, dividends have accounted for 40% - 50% of the total return on the Dow, so a higher annual payout represents a significant cumulative advantage to shareholders.

In the UK too, the 1994 BZW Equity-Gilt Study made it clear that over the previous 75 years dividends have accounted for about 42% of the nominal total return on equities. Because UK companies do not cut dividends lightly, they are also a much firmer element of total return than share price growth based on potentially volatile earnings.

There is another possible reason for high-yielders being relatively strong performers. When analysts examine a share and assess its likely future value, say a year hence, not all of them factor into the equation the extra income that is likely to be received in hard cash and could be reinvested. In some cases, it is a significant factor which is only too easy to overlook.

The arguments for buying the shares of high-yielding companies are compelling. But it is worth pointing out that there is a definite cyclicality in buying high-yielding shares. In a climate of falling interest rates, they perform well as investors become more income-conscious. However, this can easily change.

It is a dangerous game to buy shares just because they appear to have a high yield. A high yield can indicate the market's concern that the dividend may be cut. To be selective, investors following a high-yield system should avoid companies with dividends that are very poorly covered, or for other reasons seem likely to be reduced.

To help assess the risk of a dividend cut, a range of important factors is highlighted in other panels of each company entry:

1. Dividend cover - A dividend that is poorly covered is much more likely to be cut. A well-covered dividend is likely to be maintained or increased.
2. Cash flow per share - EPS provide cover for the dividend in terms of profits, but cash flow per share is a stronger test of future dividend-paying capacity.
3. Gearing or net cash - Companies with very high borrowings may have difficulty in paying dividends, even if they make substantial profits. Major creditors can press for repayment and balance sheets may need to be repaired before dividends can be freely paid.

Clearly a company with a strong dividend cover, high cash flow per share and net cash is unlikely to cut its dividend. Conversely, a company with poor dividend cover, weak cash flow and high gearing is very likely to do so.

To ensure that REFS is as up-to-date and active as possible, the dividend yield is based on the consensus of brokers' dividend estimates for the 12 months ahead. As with EPS, this is usually a combination of forecasts for the current and following financial years, apportioned on a pro-rata basis.

For example, in the October issue of REFS, the yield for a company with
a year ending 31st December includes three months of the consensus forecast for the current year and nine months of the following year's estimate.

When future estimates are available, this is indicated by the letters 'pr' in brackets, and the dividend yield is based on the consensus of brokers' forecasts for the 12 months immediately ahead. If there is no forecast, historic figures based on the last reported 12 months results are used.

As already explained, the method of calculation used in REFS ensures that the company entries are as up-to-date and dynamic as possible.

The first stage of calculating the dividend yield is to add back the basic rate of tax (1998/99 - 20%), which has been deducted by the company. Assuming a 2.1p dividend, the calculation is as follows:-

The dividend yield is the gross dividend as a percentage of the share price. If the shares trade at 200p, the calculation is as follows:

The first column of moons indicates the level of the dividend yield relative to the market as a whole, and the second column relative to the company's sector. A full black moon shows a relatively high dividend yield and a blank moon a relatively low or non-existent one.