Sonia Rehill digs into her mailbox for more of your investing questions.
Sonia is joined by David Kuo who is on hand to answer questions about SIPP protection, the frequency of dividend payments and many more. If there is a question about investing that you would like answered, please email Sonia at foolishquestions@fool.co.uk. If you would like to listen to previous episodes of Ask A Foolish Question, you can find them here.
You can download or listen to this podcast here.
Sonia:
Welcome to Ask A Foolish Question, The Motley Fool's podcast dedicated to answering all your investing questions. I am Sonia Rehill, and with me is The Fool's popular investing commentator, David Kuo. Hello, David.
David:
Hello, Sonia. Well, I told you, like a bad smell, I'll be lingering around the office, Sonia.
Sonia:
I know. We're glad you're back.
David:
Yeah, OK – you can always open the windows if you want, just to let the bad smell out.
Sonia:
Well, welcome back, David.
David:
And for those people who don't know what I'm referring to, you have to listen to last week's podcast – then you'll know what the bad smell is all about.
Sonia:
So David, we've got lots of questions this week. Shall we get started?
David:
Yes, please.
Sonia:
OK, so let's start with some questions about SIPP protection from two of our listeners. We have a question from Mr Singh, and he has all his shares with a well-known execution broker, and is thinking of transferring his stakeholder pension to a SIPP, with the same execution broker. He is nervous holding all his wealth with one broker, and wants to know if he should have all his shares and SIPP with the same execution broker. He has been informed that, even if your broker goes bankrupt, the shares and pension will still be safe. Is this correct, David?
David:
Yes, Mr Singh – you are absolutely correct. Essentially, when you use a broker to buy the shares, the broker is acting on your behalf. So therefore, he will buy the shares; they will be held in a nominee account, which is generally the name of the broker, but they are your shares. If anything were to happen to the execution-only broker, the shares are still yours. That is ringfenced, and nobody can touch that. So the administrator, or the liquidator, can come along, look at the execution broker, but all those shares that have been bought on your behalf belong to you. You are the owner of those shares, so you have nothing to worry about there. So if you want to transfer everything to one execution-only broker, that's absolutely fine, because those shares, as I stress, belong to you – not to the broker.
Sonia:
OK. What about if he has any cash left in that account?
David:
OK, this is slightly more tricky, because it depends where that cash is being held at that moment in time. This is one of those areas that is not particularly clear at the moment. So if you want a definitive answer for that, then I suggest you go to the Financial Services Authority, the FSA, and find out, number one: if the broker is registered, which I'm sure it is; who actually owns that cash, in the event of something happening to that broker, and I suspect in this particular case that that money will be protected also because it is FSA regulated.
Sonia:
OK. Paul has a very similar question: he is looking to consolidate other pensions from previous employments into his SIPP, so he can self-manage. However, because the funds are managed by a broker, rather than the SIPP trustee themselves, he's wary that there may be an FSCS upper limit that may apply, if anything untoward were to happen to either the broker or the trustee. Transferring all the pensions in to the SIPP would bring the total asset value to over £100,000. He wants to know, what are the downsides you can see from a compensation perspective, if either the trustee or broker were to go under?
David:
OK. This is a very very similar question to the one from Mr Singh earlier on, and I'm not surprised that people are very concerned at the moment about companies in the financial arena, because people just simply want to know, is my money safe? Now, OK Paul – I see your question as being of three parts. The first part is, what happens to the assets that I have? Now, if those assets are shares, then those shares belong to you, because the executioner broker has actually bought those shares on your behalf, and those are yours, and in that case, you do not really need the Financial Services Compensation Scheme to step in, because those are your assets – it is your money. Now, that is point number one. Point number two is: what happens to the cash portion, if you happen to have some cash with your SIPP deal provider? Now, this is actually less clear, and I would suggest that you go to the Pension Advisory Service to ask them to determine who actually owns this cash. This cash could be sitting with your SIPP deal provider; it could be sitting in your broker's account, and it depends where that money is at that point in time, in which case there will be an upper limit, and that upper limit could be £85,000, based on the Financial Services Compensation Scheme. There is a third part to your question, and that is, what would happen when I take that money, and I buy an annuity? Now, in that case, the Financial Services Compensation Scheme is very clear about what the compensation limits are. You are entitled to 90% of any insurance, and the reason why I mention insurance is because that is ultimately what an annuity is. You are entitled to 90% of the value of the annuity, with no upper limit whatsoever. So Paul, it is very confusing. The shares are yours; the cash has to be determined; and I would suggest, as I say, go to the Pension Advisory Service, and their website address is: pensionadvisoryservice.org.uk; and the final part, you can also ask the Pension Advisory Service to clarify what would happen to an annuity, if you were to buy it from your SIPP provider.
Sonia:
It's quite complicated, really, isn't it? – a few muddy waters there.
David:
It is very complicated, and I imagine, I'm sort of quite reassured that people are thinking about these sort of things, before they jump in and put everything with one provider.
Sonia:
Well, I hope that helps Mr Singh and Paul. Our next question is from Austin, and he wants to know, what is the best return of equity to risk profile at the moment? He has been offered a 3.1% yield on a Lloyds (LSE: LLOY) bond. He doesn't believe this is the best out there – any suggestions, David?
David:
OK, now, for those people who don't know, if you were to buy Lloyds bonds as opposed to buying Lloyds Bank shares, you rank higher than the equity holders – in other words, the shareholders, if something were to happen to Lloyds Bank. You would get paid first, before the shareholders would. Now, in terms of the equity-to-risk profile, yes – 3.1% yield on a Lloyds bond doesn't look particularly attractive. There are lots of other companies out there that are yielding possibly higher than 3.1%, and what I suggest you do, Austin, is to go and have a look at the London Stock Exchange website, because now, as retail bond investors, you can directly buy those bonds yourself. You don't need to actually go to anybody to buy those bonds. So I was having a look this morning – there is a list of literally tens upon tens upon tens of companies offering various yields. Some of the more interesting ones are British American Tobacco (LSE: BATS), Tesco's, Barclays – they're all offering different yields on their bonds. So I would suggest you go and have a look, and see which are the companies that you feel more confident about, and whether or not you want to have a look at those yields. But before I finish this question, Sonia, I'd like to say, there is an alternative to bonds, and that is to go and buy high-income shares. Now, yes – equity owners, in other words, shareholders – rank below bond holders, when it comes to paying out, but I would say that investing in something like a high-yielding share is probably more attractive than buying a bond.
Sonia:
Right, we have a question now about the frequency of dividend payments, and it's from Michael. He says, some companies pay yearly dividends, some twice a year, some quarterly, and some just pay special dividends. Is this just how company x decides to do it? Do businesses in certain sectors issue their dividends more frequently than others, and can we read anything into the frequency of dividend payments?
David:
OK, here in the UK, most companies pay their dividends twice a year. They have an interim dividend, and they also have a final dividend. Companies in America tend to pay them four times a year, so they will have first, second, third and fourth quarter dividends, and quite often those dividends are equally spaced, and they're equal amounts as well. There is no reason why a company should want to pay quarterly, or half-yearly. If you have a look at the companies here in the UK, most businesses tend to close their books in February, which therefore means that they will pay their biggest dividend around springtime, and that is the time when you expect most dividends to drop into your bank account, if you are an income investor. I have invested in a whole bunch of companies, and just by chance, this wasn't actually planned in the very beginning, but just by chance, I get dividend payments into my bank account every month of the year.
Sonia:
I know – we all see you doing cartwheels around the office, David – every month!
David:
I get paid dividends every month of the year, and you shouldn't really invest in companies in order to try and sort of get those dividends every month, but in my particular case, it just happened that way, because I have a whole bunch of shares, and some of them pay them quarterly, some of them pay them half-yearly, and it is a very very enjoyable thing to see dividend cheques dropping into your bank account, every month of the year.
Sonia:
Now, moving on, we have an email from Adam. He has been investing for around five years. He's 38, and has £26,000 in a SIPP; £11,000 in a stocks and shares ISA; and he's also just started up a company pension plan. His first question is, he currently invests around £600 per month, and he wants to know if he is on track for a comfortable retirement?
David:
OK, right – it depends on what you're investing in, Adam, but the general rule of thumb is, to take your age, divide it by two, and that should be the percentage of your income that you should be putting away for your retirement. So, in your case, Adam, you are 38 years of age. So for simplicity, I'll say you're 40 years old – divide that by two, which equals 20. So you should be putting away a fifth of your income every month into a pension, and hopefully by doing that, you will be on track to have a comfortable retirement.
Sonia:
His second question is about how he screens for new stock investments, and stocks he hopes to hold for 25 years and more. He looks for a company he understands; rising profits and sales over the past five years or more; rising projected profits or sales for the next two years; rising dividends over the past five years or more. He looks for a dividend cover of more than two; a return on equity of 15%; rising or steady margin over the past five years; debt less than three years' profits; a market cap less than 15 times yearly profits; a PE that's less than sector average; a PEG that's less than one; spread less than 5%, and positive trends. He wants to know if you have any further suggestions, or if he's missing anything?
David:
OK, Adam – it is good to have these filters; it is good to have these criteria whilst you're actually looking for shares that you want to invest in, and I do urge everybody to have these sort of criteria in place. That'll stop you from going buying shares willy nilly, just simply because you like that particular company, so that is a great thing to have. Sometimes though, Adam, you might have to relax one or two of your criteria, because it is so difficult to find the shares that you want to invest in. So you may say, I mean, I noticed here that you have, one of your criteria, market cap less than 15 times yearly profit – in other words, the PE is less than 15. You may find that yes, you may need to relax that slightly, because some of the companies you want to invest in are a little bit more expensive. I have invested in companies with a PE of greater than 15, because it is a good company. So sometimes, you mustn't get too fixated by these criteria, because otherwise you'll find no companies you want to invest in at all. Now, you asked if there was anything that you were missing. One thing that I've noticed here that you haven't addressed is something called limiting factors. Now, what I'm referring to here is, yes, by all means look at a company in isolation, with regards to all of these metrics; but also look outside the box as well. I'll give you example: let's say you're looking at a company like Domino's Pizzas (LSE: DOM), that fulfils all your criteria. Have you considered whether or not there are just too many Domino Pizzas here in the UK? If you find that there are two Domino Pizzas on one high street, or three in one particular town, then you could say that maybe, even though all your criteria are satisfied, that there might just be too many Domino Pizzas in the UK, and essentially what will happen then is that one Domino Pizza will start to cannibalise another one; in other words, it will start eating the sales from another company. So yes, it is great to have all of these criteria, but it is also important to look at it from the outside, look at the company, and say, can it sell any more pizzas than it's doing right now? And if you think that it can't, in other words, its growth potentials are more or less limited, then those are the limiting factors that you need to look for. I think you have to sort of look at a company from all perspectives, and you also have to look at something which was something that you and I talked about before we even turned on the mikes, and that is to have a look at competition, to see what the competitors are doing – are there new competitors coming onto the arena? – and those are the various things that I look at, as well as these various criteria.
Sonia:
I hope that helps you, Adam. Our next question is from Sam, and Sam has a portfolio of a lot of unit trust ISAs with Fidelity, roughly £130,000. Sam's 35, doesn't need the income, and has saved for retirement and unexpected expenses. Sam has a couple of unit trust funds that are income units, and some that are accumulation units, and is currently reinvesting all income for more unit trusts. Sam assumes this only applies to the income part of the portfolio, and goes onto say that, in previous podcasts, David, you have recommended accumulation units if you don't need the income, though Sam has decided to choose the income version, just in case he needed some income in the future. Sam wants to know if he is being penalised in some way, albeit a small difference, if he chooses an income fund with automatic reinvestment, compared to an accumulation version of the same fund?
David:
OK, I don't think there is any huge amount of difference between accumulation and income. The difference between the two is that, if you take the income fund, as opposed to the accumulation fund, it means that that money will be spat out in the form of cash. I notice, Sam, that you say that you have a lot of unit trust ISAs. Now, with the income, you can then decide how you want to allocate that cash into the various unit trusts that you have. You may, for instance, have a unit trust that is investing in the Far East; you may have one that is investing in the emerging markets; you may have one that's investing in America. With the cash that you have, you can then decide how you want to allocate that cash to wherever you think is going to have the better growth prospects.
Sonia:
So if you take the income and go back and buy the same unit trusts, David, then it kind of defeats the purpose, right?
David:
Well, that's right. If you take the income, and you're going to be buying the same unit trusts that the income came from in the first place, then you may just as well have the accumulation units rather than the income units – I totally agree with you, Sonia. But if at any point you decide, I no longer want to accumulate more of this particular fund, and I want to use that cash for investing in another fund, then at least you have that choice – you can decide. You can be the master of your portfolio universe; in other words, you can decide how I want to allocate that money, feeling a bit like Warren Buffett, because that is ultimately what Warren does. Warren has all this cash that comes in from all his little businesses, then he decides what he wants to do with it, and that is a more powerful way of investing, than to simply use those units to reinvest into the accumulation units of the same fund.
Sonia:
So with one you have control, and the other you don't.
David:
And I'll tell you one other thing that you have control over, and that is when you buy the accumulation units. If you don't want to buy them at this particular point in time, and you have the income, and if you think that the fund is going to fall in value for some reason, you can buy at some later date, and end up buying more units than you would have done, if the money was automatically invested into more units for you.
Sonia:
OK. Our next question is from John. He is a novice investor, and wants to know what stockholder's equity is. He asks: “Is it the company assets minus loans? Does the total value of the shares have anything to do with it, and if so, how?”
David:
OK, right – ultimately, what we refer to, when we're talking about stockholder equity, is the assets of the company minus the liabilities, so you're almost right there, John. It isn't the loans, but the liabilities. So you take the assets of the company, and they will include things like the fixed assets, in other words, the building, the machinery, any cash the company may have, any stock the company may have, and those are all the assets of the company, and deduct from that the loans, and also the creditors – in other words, people who have provided the company with credit. So when you subtract one from the other, that is what shareholders own, which is why it's called stockholder equity – it's as simple as that. It is what we as shareholders own, as far as the company is concerned. The share price has no bearing whatsoever on the stockholder equity.
Sonia:
Our final question is from Mark, and he would like to know, how do you work out the goodwill? Is it a figure out of a hat? Can accountants massage this figure?
David:
Goodwill is ultimately what the company is worth over and above, and it is very close to that last question that we had from John, with regards to stockholder equity. Ultimately it is what the company is worth over and above what the assets minus the liabilities of the company is. Let's take a company like Coca-Cola (NYSE: KO.US) – Coca-Cola, if it wasn't for the brand, would only be a bottler of brown fizzy drink, but the fact that it is Coca-Cola boosts the value of that company, and that value, that excess value, the brand, is what the goodwill is all about. If somebody wanted to buy the whole of Coca-Cola, they would say – I'm not just buying the assets minus the liabilities – I am buying this brand called Coca-Cola, and that brand has a premium, and that premium is what they refer to by the goodwill. It is the goodwill that that company has, how customers perceive that business, how bankers perceive that business, because when you are acquiring a company, if all you are looking at is just the assets and the liabilities – well, that would be a very boring company. Some people would buy that, because take, for instance, recently, JJB Sports (LSE: JJB) – at its peak, JJB Sports was worth over a billion pounds as a business. Why? – because it was a brand that was respected on the high street, and it had lots and lots of goodwill. Now, the moment you take away the goodwill, then all you're left with is, in the case of JJB Sports, just a retailer, and what is it worth? – well, as far as Mike Ashley is concerned, zero. All he wants to buy in that company is the stock, and maybe take over ten or twenty of those premises – that's all he wants. So he says, I will write down the goodwill to zero, because I'm not buying JJB as a brand. All I'm buying is the bricks and mortar, some stock, and maybe one or two of the brands that it has – Slazenger, and that is ultimately it – seriously, that is all it is worth. So when one company buys another company, it has to put a monetary value on the goodwill, if it is buying it as a going concern. We are talking about the brand that it has; we're talking about the employees, the management capabilities; its relationship with bankers, its relationship with customers, relationship with suppliers – all of these things form that particular goodwill. So, when your question says, can accountants massage goodwill, yes – it depends on what you place on the value of that particular company, or that particular business. So let's take, for instance, somebody who has a tea shop, right? If you are just a bog standard tea shop on the high street, making tea, well, all you're worth really is, what your turnover is, what your profit is, and a multiple of that profit, and that will ultimately be the value of your business. But the shop next door has a very strong brand, and people are willing to queue up in order to get to that shop. Your goodwill in that shop is higher than the one next door. So therefore, if the two businesses were being sold, the one that has the brand would be worth more, and the accountant would say, because of that goodwill, it is worth more than the one next door, even though the two turnovers and the two profits are identical.
Sonia:
That was our final question.
David:
I'm thirsty now, Sonia. I was talking about tea – I want a cup of tea.
Sonia:
OK, you go off and get your tea now. If you would like to get a question in for Ask A Foolish Question, please email foolishquestions@fool.co.uk, and David will be around to answer them next time, and if you're new to investing, you can download The Motley Fool's essential investor kit, and receive a free report called “What Every New Investor Needs to Know” , at fool.co.uk/questions. Thank you for listening, and happy investing.
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> David owns shares in British American Tobacco, but no other company mentioned.
