Collect the dividends while you wait for better times.
Sectors fall in and out of fashion. Think of mining stocks in late 2008, or traditional blue chips during the dotcom boom, or banks during the credit crisis.
Now, I've deliberately cited banks because they're an excellent example of the flipside to fashion -- fear!
If you were one of the many who kept buying shares in Northern Rock or HBOS as they fell, on the grounds the panic was overdone, then you'll appreciate whole sectors can become unpopular for very good reasons, too.
Today though, it seems to me that other financial companies have fallen victim to both fashion and fear, rather than the facts on the ground. The shakeout from the Madoff affair and the collapse of numerous hedge funds was very real, but it's already happened. All kinds of security markets became distressed, but most have to some extent recovered.
Profits have fallen, but so have share prices -- markedly. What we're left with is the residual and perhaps over-amplified fear that they'll not find their old strength.
Get paid for being brave
One sign that investors don't believe the worst is over for financial companies is the big forward yields they're sporting. You can hardly throw a dart at the Financial Times without hitting a fund manager boasting a FTSE 100-beating yield. Some yields are very high indeed.
By buying these companies, you could benefit from a nice income until normality returns to the sector, and then see their share prices rise to reduce their yields in line with the wider market. (Well, in theory anyway!)
Here's five such financials, in order of descending forecast payouts.
Man Group (LSE: EMG)
- Forward yield: 11.8%
- Covered by earnings? No
This week, hedge fund manger Man confounded all those who expected it to cut its dividend. Earnings continue to fall due to the duff performance of its AHL fund, but there are signs this is turning around. In the meantime, Man has the cash to maintain the dividend for some time.
Chaucer (LSE: CHU)
- Forward yield: 9.5%
- Covered by earnings? Yes (1.9x)
Another member of the 'too good to be true' club, specialist insurer Chaucer is perhaps the riskiest of these picks, given the propensity for occasional disasters to hammer insurers' profits. Then again, it only mildly trimmed its dividend after losses in 2008, and analysts are currently predicting strong profit growth in 2010. At 46.5p it's also below its estimated tangible net asset value of 59p.
F&C Asset Management (LSE: FCAM)
- Forward yield: 9.3%
- Covered by earnings? Yes, just (1.2x)
Venerable fund manager F&C has yet to prove itself as an independent company, and there are fears it may lose its biggest client, Friends Provident, from which it was demerged last year. Also, while profits are forecast to grow to cover the dividend, it paid an uncovered dividend in 2009. The balance sheet isn't particularly strong, either. Set against that is a very well-known brand name that should benefit from stronger markets and more saving.
Brewin Dolphin (LSE: BRW)
- Forward yield: 5.5%
- Covered by earnings? Yes (1.7x)
Brewin Dolphin is one of several small brokers sporting attractive looking yields. Besides the wider market woes, it suffered from queries about its reporting methods in 2009. These have since been resolved, and funds under management have been steadily rising since late last year.
Ashmore Group (LSE: ASHM)
- Forward yield: 4.7%
- Covered by earnings? Yes (1.4x)
Emerging market fund manager Ashmore Group didn't have a bad financial crisis, all things considered. Earnings fell by 20% in the year to June 2009 after several years of stellar growth -- not great, but remember the torrid conditions -- and they're already forecast to rise again this year, albeit by a modest 2%. There's no debt and £268 million in cash on the balance sheet, versus its £1.9 billion market cap.
A financial income and growth portfolio
All these companies have one or two specific worries, as well being afflicted with the general disdain for financials.
Will Man's AHL fund recover? Can Ashmore continue to thrive as every other fund manager charges into emerging markets? I don't have definitive answers, but I do feel it's unlikely that every financial company I've cited, and the many I've not, have all simultaneously gone off the rails for good.
You could get away from the company specific risks by investing in a mini-portfolio of financials:
| Company | Forward
yield |
|---|
| Man Group | 11.8% |
| Chaucer | 9.5% |
| F&C Asset Management | 9.3% |
| Brewin Dolphin | 5.5% |
| Ashmore | 4.7% |
| Average yield | 8.2% |
Not all these yields are covered by forecast earnings (and not everyone would trust the forecasts of the others!) But the financial sector is inherently cyclical, with several peaks and troughs evident during the past couple of decades. Unless you believe the credit crisis and deleveraging has changed things forever, there's every reason to think the sector as a whole will return to profitable growth.
Indeed, even if it is 'different this time', it's not clear to me that at least some financial companies won't do well in a new climate of austerity and greater savings.
With an average 8.2% yield, I think these companies have some margin of safety against bad news in the price. Better than expected news could see some nice gains, while even just a couple of middling years would reward you a decent income.
More from Owain Bennallack:
Note: Owain owns shares in Man Group and F&C Asset Management.
