We don’t yet know which stocks will feature in Neil Woodford’s new Income Focus Fund, which is targeting an initial yield of 5%.
Mr Woodford’s flagship Equity Income Fund yields just 3.2% at the time of writing, so is likely to need some fresh stock choices if it’s to perform as promised.
Having looked at Mr Woodford’s existing holdings and his market commentary over the last six months, I’m going to take a look at two companies I believe could feature.
A heavy hitter on income
If I was building a portfolio to yield at least 5%, I’d focus on buying a mix of stocks with high yields, and stocks with strong dividend growth rates.
One that might sit firmly in the high yield part of the portfolio is specialist insurance group Lancashire Holdings Limited (LSE: LRE). It paid a total dividend of $0.90 per share in 2016, giving the stock a trailing dividend yield of 10%.
It has paid similar dividends for several years. The reason for this is that the firm returns surplus capital to shareholders where it can’t find sufficiently profitable new business. Management isn’t willing to compromise on pricing in favour of growth.
The group’s financial performance reflects this conservative approach. Although its book value fell from $6.07 to $5.98 per share last year due to dividend payments, return on tangible equity rose from 11.8% to 15.7%.
Lancashire is the 17th largest holding in Woodford’s Equity Income Fund, so Mr Woodford is already familiar with the firm. Consensus forecasts indicate a total dividend of $0.66 per share is expected this year. That’s less than last year, but still equivalent to a yield of 7.3%.
Lancashire’s relatively modest £1.4bn market cap may prevent it from becoming one of the largest holdings in the new fund. However, I think that the quality of its business and the exceptional income it provides will ensure that it does make an appearance somewhere.
A top holding?
Tobacco stocks may feature among the top holdings in Mr Woodford’s new fund. But the FTSE 100 tobacco firms no longer offer yields of more than 5%. To hit its target initial yield of 5%, I believe the Income Focus Fund will have to buy some FTSE 100 names with forward yields above this level.
One possibility is general insurance group Aviva (LSE: AV). Mr Woodford’s main fund invested briefly in Aviva last November. However, the shares rallied strongly before the fund had a chance to build a substantial position. According to an update posted on the Woodford blog in January, the fund then sold its Aviva shares to wait for “a more attractive valuation.”
Aviva’s share price has continued to climb since January, but so too have its profits. The firm issued another very strong set of results in March. Cash remittances rose by 20% to £1.8bn in 2016, while the dividend rose by 12% to 23.3p.
Another 12% dividend hike is forecast for 2017. Aviva stock now trades on a forecast P/E of 9.5, with a prospective dividend yield of 5.2%. In my view, these shares remain an attractive buy. We’ll find out soon whether Neil Woodford agrees.
