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VALUE INVESTING
By
This is the latest two-monthly review of my high-yield portfolios: the first, HYP1, is about 3½ years old and the second, HYP2, is about thirteen months old. I stress that the primary aim of these portfolios is growth of income not capital, although many people use the concept as a growth vehicle by reinvesting dividends which, in my view, is an excellent idea. Note that these are merely demonstration portfolios to illustrate a high-yield approach with no dabbling. They are not a recommended set of shares, nor would I necessarily choose the same portfolios today. The strategy is intended for the very long term, ideally eternity, and it follows that short-term fluctuations are of little importance. It is worthwhile emphasising the highly attractive taxation of dividends, compared with other income in the form of savings interest, rents or pension annuities. Dividends are paid tax free to a 10% or 22% taxpayer and higher-rate taxpayers pay tax on them at only 25%. As regards capital and income, these portfolios should be considered as if they were funds, with the distinct advantage of no charges. Investors in HYPs should not pay much attention to individual share movements, which can be dramatic. Here are the latest figures; cost includes all purchase expenses. HYP1 The estimated value, including reinvested income, would be about £84,756, an increase of 13.0% on the original investment in 3½ years. This is in line with cash. The portfolio capital is down 2.4%, but remains substantially ahead of the market, which has fallen 29%. A comparison with trackers on a reinvested income basis would show it to be even further ahead, because its yield of over 4% has always been higher than the market. The familiar pattern of large individual movements continues, with the unchanged losers, Royal & Sun and Britannic, down about 80% and 68%, whilst the top gainer remains Gallaher, up 60%. HYP2 The estimated value, including reinvested income, would be about £98,052, an increase of 30.7% on the original investment in about thirteen months. This is miles ahead of cash. The portfolio capital remains well ahead of the market in its short life to date, up about 23%, compared to 18% for the latter. A comparison with trackers on a reinvested income basis would show it to be even further ahead, because of its 6% yield, which is substantially higher than the market yield. This portfolio also demonstrates large individual share fluctuations, ranging from continuing winner Dixons, up 70%, with a new greatest loser (when compared with my last review): Bradford & Bingley, down 8%. Shell previously held this dubious distinction. General Comment Cash is an important target to beat over the long term, for which these portfolios are designed. I would not be too pleased if they beat the market, yet failed to beat cash. To justify investment in equities, they should deliver a handsome premium over cash through long periods in return for their higher risks. Calculated on a reinvested income basis, HYP2 has so far done the business handsomely in this respect, whilst HYP1 is about on par with cash. If you look at the portfolios on an income withdrawn basis, as though a person was living on that income, then HYP2 is delivering a far higher income than any deposit account (6%). HYP1 paid out 4.2% last year which, at the moment, is marginally below the very best deposit accounts. However, because interest rates were lower before that and its dividends were a little higher, HYP1 was beating cash income in its first couple of years. But that's using the gross figures. Once you take tax into account, the picture is even more attractive, because the more generous tax treatment of dividends. For those seeking a growth approach with the aim of accumulating capital over the long term, I believe this strategy will leave trackers behind. The early evidence, though too soon to draw any long-term conclusions, is that it is doing just that. What makes it even more likely is the reinvestment of dividends. Because the HYP yields are so much higher than the market, the portfolios have an automatic advantage over trackers, thanks to the compounding of those higher yields over long periods. The lack of regular charges in HYPs doesn't do any harm either. Here's an example using HYP1 (HYP2 comes out even better due to its higher yield): The original yield was 4.6% but, in the third year, this dropped to 4.2%; I'll use the lower figure to be conservative. The FTSE 100 yield at the time this portfolio began was something over 2%, but I'll use 2%, to reflect a tracker's charges. If £100 is invested for twenty years at 2% compounded, it grows to £149. But, if it invested at 4.2%, the total is £228. This is a simplified example, as it ignores capital fluctuations, but I wanted to show the comparative compounding effect of different yields. I cannot be certain what will happen to the capital values of the HYPs compared with trackers but, so far, they are winning in that respect too. In my opinion, given the lack of investor involvement required, indeed advised, and the similar long-term timescales, this makes HYPs eminently suitable alternatives for those considering tracker funds. In my value newsletter, I pick a long-term hold, high-yield selection each month to show readers how to construct an HYP by purchasing suitable shares at regular intervals. Read it today with a free thirty-day trial. Stephen owns shares in Alliance & Leicester, Lloyds TSB, Mitchells & Butlers, Scottish & Newcastle and United Utilities.HYP1 - start date: 13 November 2000
£ Orig. No. Price Value Move
Invest price shs. now now %
Un. Util. (LSE: UU.) 1 5,000 620 807 538 4,342 -13.2
Gallaher (LSE: GLH) 5,000 416 1,190 670 7,973 +59.5
Scot. & New. (LSE: SCTN) 5,000 490 1,010 416 4,202 -16.0
Royal & Sun (LSE: RSA) 2 5,000 393 1,271 78 991 –80.2
All. & Leic. (LSE: AL.) 5,000 645 768 818 6,282 +25.6
Britannic (LSE: BRT) 5,000 1,020 485 330 1,600 –68.0
Lloyds TSB (LSE: LLOY) 5,000 705 702 423 2,969 -40.6
Intercon. Hotel (LSE: IHG) 3 2,500 380 658 506 3,329 +33.2
Mitchells & But(LSE: MAB) 3 2,500 356 691 253 1,748 -30.1
Boots (LSE: BOOT) 5,000 575 861 632 5,442 +8.8
Land Sec. (LSE: LAND) 4 5,000 771 651 1,085 7,063 +41.3
Ass. Br. Ports (LSE: ABP) 5,000 321 1,542 440 6,785 +35.7
Hilton (LSE: HG.) 5 5,000 232 2,275 245 5,574 +11.5
Rio Tinto (LSE: RIO) 5,000 1,120 442 1,257 5,556 +11.1
Anglo American (LSE: AAL) 5,000 942 526 1,121 5,896 +17.9
Shell (LSE: SHEL) 5,000 572 865 396 3,425 -31.5
Totals 75,000 73,177 -2.4
FTSE100 6,274.8 4,438.2 -29.3
Income Yield on capital invested %
Year ended 13/11/01: £3,451 4.6
13/11/02: £3,474 4.6
13/11/03: £3,197 4.3
Notes
1. United Utilities cost per share and total holding amended following rights issue.
2. Royal & Sun cost per share and total holding amended following rights issue.
3. Intercontinental Hotels and Mitchells & Butlers were acquired as a result of the
division of the former Six Continents holding into these two new shares.
4. Land Securities reorganised in September 2002, resulting in a cash payment that
was used to purchase additional shares in the company.
5. Hilton replaced Blue Circle, which was taken over for cash at a profit over the
£5,000 cost, the whole of the proceeds being reinvested. This is why the total
original cost of Hilton derived from the above table is more than £5,000. The
start investment of £5,000 has though been retained here, so as to maintain the
original cost of the portfolio at its true figure of £75,000.
HYP2 - start date: 02 April 2003
£ Orig. No. Price Value Move
Invest price shs. now now %
Lloyds TSB (LSE: LLOY) 5,000 338 1,479 423 6,256 +25.1
Scot. & New. (LSE: SCTN) 5,000 348 1,436 416 5,974 +19.5
Dixons (LSE: DXNS) 5,000 87 5,762 148 8,528 +70.6
Un. Util. (LSE: UU.) 1 5,000 546 915 538 4,923 -1.5
Hays (LSE: HAS) 5,000 78 6,435 115 7,400 +48.0
Legal & Gen. (LSE: LGEN) 5,000 75 6,696 90 6,026 +20.5
BA Tobacco (LSE: BATS) 5,000 580 862 818 7,051 +41.0
Brad. & Bing. (LSE: BB.) 5,000 297 1,685 274 4,617 -7.7
Hanson (LSE: HNS) 5,000 320 1,563 414 6,471 +29.4
Land Sec. (LSE: LAND) 5,000 736 680 1,085 7,378 +47.6
The BOC Group (LSE: BOC) 5,000 795 628 888 5,577 +11.5
BAA (LSE: BAA) 5,000 465 1,075 538 5,784 +15.7
Shell (LSE: SHEL) 5,000 394 1,271 396 5,033 +0.7
AMVESCAP (LSE: AVZ) 5,000 311 1,609 356 5,728 +14.6
Anglo American (LSE: AAL) 5,000 970 516 1,121 5,784 +15.7
Totals 75,000 92,530 +23.4
FTSE100 3,753.4 4,438.2 +18.2
Income Yield on capital invested %
Year ended 02/04/04: £4,564 6.1
Notes
1. United Utilities cost per share and total holding amended following rights issue.