‘Dividends Don’t Lie: Finding Value in Blue-Chip Stocks” is a well-regarded book by Geraldine Weiss, the former editor of the newsletter, Investment Quality Trends.
While the rest of the investment world was focusing on price/earnings ratios – the share price divided by the earnings per share – back in the seventies and eighties Weiss was championing an investment strategy that focused on the dividend yield – dividend as a percentage of share price – of blue chip companies.
In particular, she looked for companies with a yield that was close to the top end the historical range, which she regarded as a potential ‘buy’ signal. Likewise, stocks with a yield that was towards the bottom of the range were regarded as overvalued.
There were a number of other filters she looked for, many of which we will look at in this article.
The book was written in 1990, since when everyone and his dog has gained access to share prices and the computing power to crunch the numbers. In theory, therefore, the chances of a strict application of Weiss’s filters turning up undiscovered gems are practically zero, as the minute any stock falls into buying range, the algorithmic trading automatons at the big investment banks and fund managers should pile in.
Instead, we are going to investigate what I have called the Geraldine Weiss Champion Hurdle, applying additional filters as we go along and seeing which ones fall at a particular hurdle, and which ones run on.
Hurdle number 1: Does it pay a dividend?
There are 967 stocks on the LSE that have a dividend yield, which is to say they paid a dividend in the last 12 months.
Excluding venture capital trusts (which are closed-end private equity investment schemes), the highest yielder is Trading Emissions PLC (LON:TRE), the solar power company that is selling off a portion of its Italian solar portfolio and returning cash to shareholders.
Valued at just over £5mln, it is no one’s idea of a blue-chip.
Of the FTSE 350 stocks, Talktalk Telecom Group PLC (LON:TALK) is the highest yielder at 9.7%. My old mum used to say to me (well, let’s imagine she did for the sake of this article) beware of any stock yielding more than 7%, as it means the market thinks a dividend cut is on the way.
Weiss had a filter for sniffing out potential dividend cuts that we’ll get to in a later article, but for information purposes only the other FTSE 350 stocks yielding more than 7% are: Redefine International, Carillion, Pearson, Aberdeen Asset Management, P2P Global Investments, Centamin, Cobham and NEX Group.
2. Is it yielding more than its average yield over the last 10 years?
About half of the ‘horses’ fall at this particular hurdle, reducing the field to 499. Of the FTSE 350 runners & riders, Redefine and NEX Group fail to make the cut.
3. Is the yield towards the top end of the historical 10 year range?
Restricting the selection to those stocks yielding 1.5 times their 10-year average yield cuts the list to 190 stocks.
A number of stocks catch the eye yielding many times their historical average; this can either be a good sign – signifying handsome dividend growth – or a bad sign, signifying the market thinks the divi is not copper-bottomed.
In the case of Newmark Security PLC (LON:TCM), for instance, which is yielding 3.3 times its historical average, the signs look positive as the company upped its dividend in 2014 and 2015 and maintained it in 2016, despite issuing a profit warning last year.
A bit more digging would be necessary to determine whether Newmark is worth buying, but under Weiss’s system – or at least the parts of it we have applied so far – it might be that the profit warning has battered the share price enough for the stock to be worth pocketing for the dividend.
In the case of Fairpoint Group, yielding 5.9 times its historical average, the signs are negative, as the company has signalled it will suspend dividend payments until new management has righted the ship.
4. Does it have a record of growing dividends over the last 10 years?
Weiss apparently looked for stocks that had raised dividends at a compound annual rate of at least 10% over the past 12 years.
Our data only goes back 10 years, so a compound annual increase of at least 10% over that period equates to an aggregate increase of about 160%.
That filter reduces the size of the list to 31 stocks. Oilfield support services firm Petrofac Limited (LON:PFC) was the stock to own over the last 10 years for dividend growth, with the divi up (in sterling terms) from 8.15p in 2007 to 46.87p in 2015/6.
5. Is it selling for two times less than book value?
Proving that Weiss was not totally averse to looking at the fundamental value of a company, she liked to filter out stocks that were valued at more than twice their book value (or net asset value, if you prefer).
This hurdle knocks another nine runners out of the race, leaving 22.
Again, excluding venture capital trusts, the cheapest stock appears to be Pebble Beach Systems Group PLC (LON:PEB), the software and technology company formerly known as Vislink.
As the company announced earlier this week it would be restructuring and parting company with its executive chairman after putting out a profit warning earlier this month, it is probably safe to assume this one would not meet Weiss’s definition of a “blue chip company”.
6. Is it trading on an earnings multiple of less than 20?
Everyone likes a bargain, and Weiss was apparently no exception, though I am not sure why she chose the cut-off point of a price/earnings ratio of 20.
We’re getting down to the nitty-gritty now, with just nine survivors. Screening out venture capital trusts leaves just five, and one of those is Pebble Beach, so in reality we are down to just four companies in what has been more like a steeplechase than a hurdle race.
Those four are (drum roll, please): Mitie Group PLC (LON:MTO), Aberdeen Asset Management PLC (LON:ADN), RPS Group PLC (LON:RPS) and UNITE Group PLC (LON:UTG).
All of those are worth looking at in more detail and applying a few more of Weiss’s filters, to see whether they make the grade, but that will have to wait for another day.