VALUE INVESTING
How Important Is Yield?

By Stephen Bland (TMFPyad)
May 6, 2005

Very. At least, to the two strategies featured in my tipsheet Value Investor.

These consist of short-term share trading for capital gains and the long-term high-yield portfolio. The HYP is dual purpose, in that it can be used either for immediate income, or as a long-term growth vehicle by reinvesting dividends until such time as the investor needs that income.

But why do I consider dividends and yields to be important for these strategies?

Because yield is a double-edged weapon for equity investors who follow my styles.  It both tells you how much income to expect from a share and also acts as a value indicator.

Shares with much higher yields than the market are better value than those with lower yields. If the market is yielding 3% and you have a share yielding 5%, then that share is better value than the market. For some reason, the market has decided that this share should be cheaper on yield than the average return at that time. You would need to investigate the reasons why but, on the face of it, this share is offering you value.

Secondly, irrespective of value indication, the yield is saying that you will receive an initial 5% income on the money that you have invested in that share and, moreover, this is an absolute, not a relative, fact. What I mean is that once you have invested in it, regardless of its future price movements or that of the market, you will get your 5% at least, assuming dividends are maintained or increased.

Many other fundamentals will also give you a view of the relative opinion the market has of a share, probably the most common being the P/E ratio and the value favourite, P/TBV. But the major difference between yield and other relative value tests is that it informs you of the expected level of cash income, in addition to its merits as a value test.

So important do I consider yield to be for value that in addition to using it as part of my short-term trading selection filters, I built a whole HYP strategy around it and decided to make that a permanent feature of Value Investor. I believe, and there is a lot of research evidence to support my claim, that high-yielding large caps beat the market over long periods. Critically, a very significant part of this total return outperformance is down to the dividends.

The Value Investor HYP has not been going long enough to produce long-erm results but, nevertheless, I can see the beginnings of this dividend effect, even in the short period to date. Take Alliance & Leicester (LSE: AL.), my very first selection back in January 2004. In our latest scorecard and as at 13 April 2005, the share price was down from 906.25p to 868.5p, a fall of 37.75p, or 4.2%. But dividends paid to date total 77.9p, equivalent to 8.6% of the purchase cost, and a huge figure relative to the movement in the share price. Big enough, in fact, to turn the 4.2% loss on capital into a total return of +4.4%.

Or take Shell (LSE: SHEL), my second Value Investor HYP selection dating from February 2004, and a much lower yielder than Alliance & Leicester. The share price has risen from 363p to 484p, a gain of 121p or a third. Dividends to date total 26.6p, equivalent to 7.3% of the purchase cost, to give a total return of 40.7%, a very worthwhile boost to already pretty good pure capital return.

Similar comments about the contribution by dividends to total return could apply to any of the shares in the portfolio held long enough to produce sufficient income. If dividends can boost returns by so much in the short term, then consider how beneficial this effect is likely to be over the very long term intended for HYPs.

As at 5 May 2005, the Value Investor scorecard showed an average gain of 9% from 56 recommendations.

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