How To Make Money From a Falling, or Rising Stock MarketWe’d all like to make money when the markets are falling, wouldn’t we? This article will explain, in layman’s language, how this works - No scams, very little risk to your capital outlay, coupled with a buy and forget regime.
In one of the longest bear markets since the war, most people who invested in the stock markets this millennium, would have seen significant chunks taken out of their portfolio values. I am no investment guru, therefore I have suffered the same, except that the total return on my portfolio is up by just over 1%. This, in a time when, if the FTSE100 increased by two thirds, it would still be worth less than it was in the last week of 1999!
How have I achieved this? By investing for an income.
I set out to put together a portfolio of shares based on the following rules :-
I would only select shares with a market capitalisation of greater than one billion pounds so as to ensure that the company was not in danger of going broke - It does happen, but only very rarely.
That the dividend is covered by earnings. It is no use buying into a company with a high yield, if that yield cannot be maintained. I will define dividend cover later.
I would select between ten and fifteen shares and each one would be from a different market sector for diversification purposes. At any one time, whether in a bull or bear market, sectors can be hit by adverse trading conditions - Best not to put all your investment eggs in one basket case!
Before I show how to make, not insignificant, amounts of money using this principle, let’s go through a few definitions.
Dividend Yield - Not all companies pay dividends. Newer companies, or those that are going for growth, use their profits to re-invest in the business. Well-established businesses that have already grown and realistically cannot continue growing at the same pace as before, need to attract investors by paying dividends. This is effectively a return of profits back to their shareholders. If a company’s share price is currently 100p and they return 3p per year in the form of dividends, then the annual yield is 3% (3p / 100p).Dividend Cover - This is simply the number of times that the dividend can be paid out of profits. If a company’s annual EPS (Earnings Per Share) is 4.5p and the annual dividend is 3p, then the dividend cover is 1.5 (4.5p / 3p).
This is all we really need at this stage, so let’s move on to how it works using an example.XYZ Holdings share price has been floating around the £1 mark for the past couple of years. There has been take-over activity in their sector and investors are worried that the potential increased competition will cripple their profits. City institutions start selling, private investors see this activity, panic and start selling too. Within a few days, XYZ’s share price has dropped to 50p. This is a typical market over-reaction and one which makes the company’s share pop up via our selection filters. I’ll quickly remind you of what these are :-
a) Market capitalisation greater than £1b ? - Yes, still true;b) Dividend covered ? - Yes, EPS is 6p and they are still paying only 3p in dividends;
c) Trading at less than 25% of their all-time high ? - Yes, they were around £1 and are now 50p so they are 50% down.So why does XYZ’s share now suddenly get selected by our filters? Remember the yield was 3%, but now it’s 6%. Why, because the share price is now 50p and the dividend is still 3p, the yield has doubled (3p / 50p = 6%). The only other criterion that we must satisfy, is that we already don’t own a share in XYZ’s market sector. For argument’s sake, lets say that we don’t, so we pile in and buy, say £10,000s worth. Quick recap - We’ve now just purchased 20,000 XYZ shares at 50p each with a 3p per share dividend, giving us a yield of 6%. Unless XYZ reduces the dividend due to prolonged adverse conditions affecting the EPS, this is the yield we will enjoy forever. A common misconception is that if the share price increases, the yield decreases. This is true before you buy, but when you already own the shares, the yield stays at the level that it was at the time of purchase, regardless of the current share price. Due to the over-reaction as mentioned above, XYZ’s share price recovers almost to its ‘normal’ level of around £1. For argument’s sake, let’s say that they are now changing hands at 80p.
How have we fared then? Firstly, we have enjoyed a 60% increase in the share price (30p / 50p). 30p being the increase in the share price and 50p being the price at which we bought. Even if this occurred slowly over a period of two years, that’s still an annual return of around 30%.
Secondly, we are getting an income of 6%, because that was the yield at the time of purchase. So now, in addition to the increase in share price, we are also receiving an annual income of £600 in dividends (20,000 shares x 3p dividend).This is where the ‘buy and forget’ regime comes in. Unless you really have to, don’t ever look at the share price after purchase. If you do, and the price has increased significantly, then you may be tempted to sell to realise your profit. The downside to selling is of course, that you cut off your income stream. If the share price has decreased significantly, then you may panic into selling at a loss and again, cut off your income stream. The only reason for selling is if XYZ decides to cut the dividend reducing your income. Then you should sell up and look for another company out of favour.
As an added bonus, unless you are a higher rate tax-payer, then you will receive this income, tax free, because dividends are effectively, pre-taxed, i.e. paid net. Using the example above, which is not uncommon, where else can you get a 6% net return? Even if you are a higher rate tax-payer, then you will only pay 25% on the income via your self-assessment tax return form.
For all the information you need to pick the highest yielding shares from the FTSE350, visit www.itpaysdividends.co.uk
Roughly translated means ‘Hurry, Before The Bulls Arrive’. No, I’ve not had an attack of Europhilia (is that a word?!), nor am I succumbing to all the media hype about Beckham and Real Madrid, rather I thought I’d give you a quick wealth warning.
If you believe any of the stories which are going around these days, no doubt prompted by the fact that the FTSE100 has increased by some 20% since hitting its low a few months back, we are being warned of a bull market. No, not in Real Madrid, but here in London. Some city analysts, (you know, those people who we trust implicitly and always know what is going to happen in the next few months!), are saying that we are heading for a bull run.
I used the word ‘warned’ above, because this is exactly what Dividend Yield Investors don’t want. We like depressed share prices, because a) It means we can buy shares cheaply, thus getting more shares for our money, and b) The shares we buy give us higher yields, therefore better long term income.
A quick example of this is if a share price is 100p and the current yield is 4%, we receive 4p per share per year. If we have £1000 to spend, we can buy 1000 shares and receive £40 per annum, tax free*. If the share price falls to 80p, then the yield at purchase time, is 5% and we can afford 1250 shares giving us an annual income of £50.
Contrast this with what happens in a bull market. The share price goes to say, 125p, which means that the yield is now going to be 3.2% and we can only buy 800 of them. Our income is now down to £32 - not good. At the risk of getting slightly convoluted, the difference between 5% income and 3.2% is 36%.
The only time we should ever want a bull market is a) We’re selling shares, or b) We are buying beef in the Real Madrid meat market to take round to Posh & Beck’s barbecue. Bear markets are wonderful opportunities for stocking up on your favourite high yielding shares. Bull markets are where we sit back and reap the benefits of our previous purchases.
So what do I think about the chance of us entering a bull run in the next few weeks? Personally, I think its a load of bullocks!
Ÿ For higher rate tax payers only, there is an additional 25% tax to pay via your self-assessment forms.
Hasta la vista. Estoy apagado a la barbacoa de oro de las bolas.
There's Safety in Numbers
There has been some debate recently
as to the safety of dividends. It is generally accepted that with historically
low interest rates, the best way now of receiving a decent income, is by
constructing a portfolio of shares which produce an income via dividends, also
known as a High Yield Portfolio.
One of the reasons why shares have nearly always out-performed any other form of investment such as bank deposits, is that they can be inherently risky. Bank deposits are considered to be 'as safe as houses', hence the reason why people expect a better return from shares, because investors are taking a risk. You may lose some, or all of your capital. You may invest for income and those high yielding companies may in bad times, cut their dividends, thus cutting off your income flow.
So, the question is "How do you identify those companies which are currently paying high yields, but will not cut, or reduce their dividends?" There are two schools of thought on this, one is to use dividend cover, the other is to pick companies which have consistently increased their dividends.
Let's start by quickly defining what we mean by the terms 'dividend yield', 'dividend cover' and 'increasing dividends'.
Dividend Yield - Not all companies pay dividends. Newer companies, or those that are going for growth, use their profits to re-invest in the business. Well-established businesses that have already grown and realistically cannot continue growing at the same pace as before, need to attract investors by paying dividends. This is effectively a return of profits back to their shareholders. If a company's share price is currently 100p and they return 3p per year in the form of dividends, then the annual yield is 3% (3p / 100p).
Dividend Cover - This is simply the number of times that the dividend can be paid out of profits. If a company's annual Earnings Per Share (EPS) is 4.5p and the annual dividend is 3p, then the dividend cover is 1.5 (4.5p / 3p).
Increasing Dividends - This is simply the situation whereby a company pays out more one year than the last. For companies to qualify for those that 'increase dividends', it is generally accepted for them to have done so for the past five years.
So let's get back to those two schools of thought on share selection using current data and based on the FTSE350 only. The reason for using the FTSE350 as a base, is that any company outside of this index is going to have a market capitalisation of less than around £100m and therefore potentially more risky in terms of going broke. We are going to use practical examples of selecting FTSE350 companies, picking a ten share portfolio with the highest yields using A) dividend cover only, B) increasing dividends only, C) neither, and D) both. We will then compare the results from each method.
A) The Dividend Cover Method
For companies to have a 'safe' dividend cover, it is generally accepted as being at least a cover of 1.5, see 'Dividend Cover' definition above. If we sort the FTSE350 by cover and strip out those companies with a cover of less than 1.5, we end up with a list of 219 companies. We have of course, automatically stripped out those companies that do not pay dividends, because they will effectively have a dividend cover of zero.
If we now re-sort by descending yield and pick the top ten companies, we end up with a portfolio averaging 6.27% yield, a cover of 1.9 and a P/E of 10.0 (for those who like P/Es in the equation).
B) The Increasing Dividend Method
If we start again from the full FTSE350 list and exclude those companies that have not regularly increased their dividends over the past five years, we end up with a list of 178. That in itself is interesting - almost exactly half of all companies in the FTSE350 have increased their dividends in the past five years. Again, we have automatically stripped out those companies that do not pay dividends, because of the fact that this year's dividend of 0p is 'not greater' than last year's dividend of 0p.
If we now re-sort by descending yield and pick the top ten companies, we end up with a portfolio averaging 6.24% yield, a cover of 1.4 and a P/E of 12.5.
C) Using Neither Cover, nor Increasing Dividends
This time, we will simply sort the FTSE350 by descending yields, applying no other filters and selecting the top ten companies. Here, we end up with a portfolio averaging 7.38% yield, a cover of 1.4 and a P/E of 12.0.
D) Using Both Cover and Increasing Dividends
This time we will start by excluding those companies that have not regularly increased their dividends over the past five years. After excluding those that also have a cover of less than 1.5, we end up with a list of 139 shares.
If we now re-sort by descending yield and pick the top ten companies, we end up with a portfolio averaging 5.39% yield, a cover of 1.7 and a P/E of 11.1.
Coming back to the issue of safety in numbers, sorting the four selection methods by increasing levels of risk, we get D) Using Both Cover and Increasing Dividends, A) The Dividend Cover Method, B) The Increasing Dividend Method and C) Using Neither Cover, nor Increasing Dividends. Depending on which school of thought you subscribe to, methods A) and B) could be transposed.
Let's now look at the numbers produced by these four selection methods and compare them with each other.
The highest yielding portfolio was produced, not surprisingly, by C) Using Neither Cover, nor Increasing Dividends. It produced a yield of 7.38%, but at the risk of the dividends being cut. Only three companies in this portfolio have increased dividends and six have a dividend cover of less than 1.5. In fact one company has a cover of only 0.6, which is a fair indication of unsustainability. Only one share has a reasonable 'comfort factor'. It has a cover of 1.8, has increased dividends and has a yield of 6.53%.
The lowest yielding portfolio, as you would expect, comes from method D) Using Both Cover and Increasing Dividends. In producing a 'safe' portfolio, we have sacrificed some income. It's still not bad though, with a yield of 5.39%, much better than even high interest bank accounts.
This next bit is interesting for those who are advocates of using either dividend cover, or rising dividends for selecting shares - There's no difference in the results! Well alright, there is a difference of 0.03% in favour of the 'cover' method, but that's only going to increase your wealth by 30p per year for every £1000 invested. The trade-off is that with the cover method, the average cover is 1.9, whereas for the increasing dividend method, the cover is 1.4, so the former is possibly safer. On the plus side for the increasing dividend method, as the dividend has been regularly increased over the past five years, there is a good chance that they will continue to do so. Not guaranteed of course, but it does show that those companies will do so if they can, and probably have a policy document which states so. Bearing in mind the minimal difference between the two methods, I'd personally choose the increasing dividends route with a still reasonable, cover of 1.4.
In conclusion, you need to identify your own personal risk profile, which you should have done anyway if you have entered the world of investing. Are you a risk taker? If you are, then you probably are not too interested in income as it is too slow and secure. If you are not, then you need to identify just how much risk you are prepared to take. The ultra-safe route of the increasing dividends AND high dividend cover, or the less conservative 'neither' model. Either way, you will be investing in safe companies with good track records which pay an income of at least 25% above high interest bank accounts.
For all the data you need to put together your own High Yield Portfolio, including five year dividend history and payment and ex dividend dates for the entire FTSE350, click here. All data is based on closing prices each Friday and can be supplied either weekly, or monthly.