VALUE INVESTING
The Best Dividend Payers

By Stephen Bland (TMFPyad)
August 6, 2004

Following last week's article on the progress of my two demo high yield portfolios, I thought it might be worth considering the situation of level yields compared with increasing yields on particular shares. I was minded of this when running a high yield filter on the FTSE350 in preparation for this article. What you cannot fail to notice is the large number of banks that show up on such lists at present, indicating the unfashionable nature of the sector. Unfashionable sectors are excellent hunting grounds for high yield players and this is one of the reasons that the concept is so successful – beating the market depends upon doing something different to the market.

My original thought for this article was to point this out and suggest that, in consequence, this is a good time for high yield investors to add one or more banks to their portfolios. However, there have been other articles recently on the Fool on this subject so instead I am going to look at whether a high, but unlikely to increase, yield may or may not be preferable to a lower but likely increasing yield.

The question was prompted by the yield on Lloyds TSB (LSE: LLOY) at 416p which, at around 8.2% forecast, stands way out above all the other banks and in fact the whole market too. Amongst the other top bank yield leaders are mortgage lenders Bradford & Bingley (LSE: BB.) at 6.9%, Alliance & Leicester (LSE: AL.) at 6.0% and Barclays (LSE: BARC) on about 5.2%. All of these yields are much higher than the market and there is no suggestion of dividend cuts either, though there can never be any guarantee of that.

Note that Lloyds has maintained its dividend at the same level for some time and is forecast to continue this for the time being. So, for yield players is 8.2% with no increase better than say 6.0% rising at 10% per year? The answer depends on how long you've got.

Although the rising dividend will overtake the level dividend in a little over three years, the cumulative cash received from dividends will take just over seven years to equalise. After that the rising dividend wins. All very theoretical of course because it is impossible to forecast dividend levels that far ahead but this kind of analysis may help in the decision process between two such shares. It's not just academic, this actually needs to be considered now by those looking at Lloyds compared with other banks. I stress though that readers should not get too hung up on the figures simply because there are too many unknowns. Lloyds could resume increases – it had a fine history of good rises until a couple of years ago - whilst the other banks could level off.

Here's a table comparing level with rising dividends where the latter is increasing by 10% per annum.

Level Dividend          Rising Dividend       Years to equalise cum.
                      (as initial % of LD)

    100                      50.0                        14
    100                      66.7                         9
    100                      75.0                         7
    100                      80.0                         6

And at 5% per annum

    100                      50.0                        27
    100                      66.7                        17
    100                      75.0                        12
    100                      80.0                        10

You can play around with other percentages but obviously the lower the rate of growth for the rising dividend the longer the cumulative cash received by the investor will take to equalise the yield from a higher but level dividend. Note though that the longer the period being considered, the less certain the whole exercise will be.

For example in the 5% increase table above, where the rising dividend starts off at 50% of the level figure, it takes 27 years before the total income received is equal to the level amount. Although that is the sort of period for which I advocate HYPs are held, it is so long that nothing about anything can be known. How likely is it that one company will return the same dividend every year over that time or that another will increase its dividend by 5% every year?

Consequently do be careful before using this sort of analysis on comparative dividend figures. The fact remains though that investors choosing between Lloyds and the other banks do have to make some sort of judgement on the dividends because of the very large disparity between them, quite apart from any other considerations.

Not that I personally advocate much attention be paid to other considerations. Ignorance is knowledge with HYPs, by which I mean that trying to divine the future from macro considerations about the future of the economy in general or the sector in particular is worse than useless. The less you know, or talk yourself into believing you know, the more you know.

As it happens, Lloyds was the latest selection in the high yield portfolio I am constructing monthly in my Value Investor newsletter. Click here for details of how to get a free 30-day trial.

Stephen owns shares in Lloyds TSB and Alliance & Leicester.