Investec: Beware Dividend Yields That are Too High

Investec's Blake Hutchins says: "it annoys us when companies really mess up their dividend policy"

Emma Wall 7 March, 2018 | 8:40AM
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Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Blake Hutchins, manager of the Investec UK Equity Income Fund.

Hi, Blake.

Blake Hutchins: Hi, Emma.

Wall: So, we are about 700, 800 points down since the beginning of the year. The FTSE peaked on January 12th, I think, it is. And now, we are just above 7,000. I wouldn't say it was a huge drawback in terms of the market now looks very cheap. But it must have created some opportunities for UK equity investors such as yourself?

Hutchins: Yes, I think, that's absolutely the case. I mean, if we look back towards the end of last year and December, in particular, it was incredibly strong. There were signs of overheating markets over the Bitcoin phenomenon and everything like that. And I think now we have had a pullback in equities. There are some better incremental buying opportunities.

I mean, for me, the Investec UK Equity Income Fund has a very much a quality bias. And it's interesting to me that within that pullback a lot of these resilient and consistent compounding businesses seems to have fallen back quite indiscriminately. So, for me, that's where the incremental opportunity is.

Wall: I think that quality is a very interesting word. It means different things to different people. But we have seen some income investors get unstuck in recent months because there have been some companies in the UK tend to be domestically-focused who had these very high, very attractive dividends yields which actually proved to be a warning because they have subsequently come a cropper.

Hutchins: Yeah. I think that's it. I mean, dividend yields it's something to be just be optically high and it annoys us when companies really mess up their dividend policy because it's the one thing they can determine. They can't really determine the macro environment or what their profitability is going to be in a short period of time. The one thing they can control is their dividend policy.

And for us, it's all about finding dividends that are backed by cash flows. If you do that, and if you focus on free cash flow generation, which is, as I say, our primary methodology for valuing companies and analysing the sustainability of dividends, I don't think you will go too far wrong. And those companies that you highlighted interestingly have very questionable or poor record of cash generation.

Wall: And what about the breadths of income that's available in the market? Because rewind about 18 months ago, you were seeing a lot of large companies cut their dividend, which it sounds like you would rather a company did than carried on paying something they couldn't afford. But are we in a more healthy environment now? Are there more options available to income investors?

Hutchins: I wouldn't necessarily say that the situation has changed too much. I think the one thing that is interesting is, there are a lot of companies that are still overpaying, paying multiples of their free cash flow or if not, certainly stretched amounts of their free cash flow. But the thing that I like to look at in the markets at the moment is that those companies that are actually paying quite sustainable dividends, some of the good growing consumer staples companies, some of the more stable media companies, the software companies, they have actually been sold off.

So, whilst they haven't really changed the level of dividends they are paying, their prices got cheaper. So, their yield is more attractive. And if prices have lower, and nothing has changed, for us, that's a great time to incrementally add some to those holdings.

Wall: Blake, thank you very much. This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Ninety One UK Equity Income I Inc 2125.20 GBP1.21Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar

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