There’s a running gag on the Proactive editorial team about the use of the phrase “that rarity on Aim, a dividend paying stock”.
The truth is there are just under 270 stocks on Aim that are paying a dividend, which is just over a quarter of them.
It is also true that very few of them are what you might call hard core income stocks.
That’s not really what Aim is all about. It’s meant to be a market for growth stocks and companies, to use the marketing jargon, with “blue sky potential”.
A lot of the stocks are paying a dividend almost as a way of flagging up “hey, we’re making (some) money, rather than pouring it down a hole in Shurugwi”.
Take stock market darling Fevertree Drinks PLC (LON:FEVR) – we wish we had a year ago – which doubled its dividend to 6.25p in respect of 2015 but is still only yielding 0.4%.
Show me the money
So, the theme of today’s Stockpot is screening for Aim companies that are paying a sustainable dividend, in the hope we can identify some stocks that are going to reward us for holding the shares while, hopefully, the growth company does its stuff and grows.
Just to make sure, however, that a company is making money rather than just borrowing to reward shareholders, I added a couple of other filters to my stock screen:
- Forecast dividend cover of at least 1.25
- Free cash flow dividend cover of at least 1.0
The first ratio uses the consensus dividend and earnings per share (EPS) forecasts for the current year. A dividend cover ratio of at least 1.25 just means that the EPS this year is expected to be at least 1.25 times the level of the divi.
The second ratio looks at the free cash flow from the most recent full year results and checks to see whether this is at least equal to the amount the company paid out in dividends.
Free cash flow is essentially the pounds, shillings and pence (How old is this guy? – Ed.) the company has generated after accounting for capital expenditure on things such as buildings, plant and equipment such as fax machines (We need to get him more modern reference materials – Deputy Ed.)
Elvis may have been the king*, but we prefer Johnny Cash
Cash is king, they say, and focusing on this can give a clearer idea of how well a company is doing; not that negative free cash flow is necessarily a bad thing, as it could mean the company is investing heavily for the future, but in terms of underpinning the current dividend, positive free cash flow is a good thing.
Applying those two dividend cover filters narrows the Aim dividend payers universe down to 118 companies, which is a bit large for a portfolio.
We can get that number down to 83 by looking at a company’s debt versus its free cash flow, and filtering out those stocks where the debt is more than three times free cash flow.
I’ll admit this is a fairly arbitrary number, based on nothing more scientific than the old habit of mortgage lenders not wanting to lend much more than three times a person’s annual earnings.
As a failsafe to the above, I also looked at net debt to underlying earnings, or EBITDA, as this is often a covenant built into banking facilities. Setting a ratio of 2:1, i.e. net debt no more than double EBITDA, left the universe unchanged, which just goes to show that sometimes a belt is enough and you should dispense with the braces.
Growth companies tend to soak up a lot of cash in the land-grab phase, and I am happy with free cash flow per share typically being less than earnings per share, but there is a limit, and that limit is 75%.
More specifically, the filter limit I set was for average free cash flow per share over the last five years to be at least 75% of average normalised earnings per share.
I like companies that are essentially still ploughing the bulk of their profits back into the business to maximise growth potential, but I also like companies that do not have a heavy capital expenditure commitment, so I also looked for companies where capital expenditure is, on average over a five-year period, no more than 30% of operating cash flow.
That may be on the low side for a growth company, but then again a lot of Aim companies are asset light and there is a limit to the amount they can splurge on new assets.
Stick all of the above into the mixer and the stock screen spits out 38 stocks, which is still too many for a portfolio.
Ensuring the amount owed to the company is no more than 25% of annual turnover pares the field down to 26, and guards us a little against a company growing its top-line by being too indiscriminate in taking on slow-paying customers.
Revisiting our old friend, free cash flow (FCF), and ensuring that the free cash flow margin – FCF as a percentage of turnover – averages at least 10% over five years whittles the field down to 13.
The lucky 13
For the record, here is the list of 13, with the forecast dividend yield in brackets after the name of the company:
- NAHL Group plc (10.0%) [sic]
- NetPlay TV PLC (6.8%)
- Dillistone Group PLC (4.9%)
- Zytronic PLC (4.1%)
- Somero Enterprises Inc (3.1%)
- James Halstead PLC (2.7%)
- Miton Group PLC (2.3%)
- RWS Holdings PLC (2.0%)
- Taptica Ltd (1.9%)
- Abcam PLC (1.2%)
- Franchise Brands PLC (0.5%)
- Advanced Medical Solutions (0.4%)
- Tracsis PLC (0.3%)
The stock screen was not set up specifically to identify high-yielding Aim stocks, but if we have a list of 13, which is more than enough, we might as well kick those yielding less than inflation (2.3%) into the long grass, even though it means saying farewell to some interesting stocks, such as Taptica, the mobile advertising platform operator, and Abcam, the rabbit antibody company.
Feel free to do your own research on that pair and any of the other low yielders given the elbow.
As for the remaining half dozen, I’ll look at them in more detail later this week, especially the top two, where the $64,000 question is: can a dividend yield be too good?
* Actually Chuck Berry was the king, but I don’t want to start an argument