Mixed performance on dividends
Legal & General’s dividend record is impressive. The firm has pushed its dividend up around 123% since 2011 and City analysts following the firm expect a further 6.3% boost to the payout during 2017.
Meanwhile, G4S has a lacklustre record on dividends. Since 2011 the payout has grown just 11%. However, expectations are for a further 4.4% hike in 2017. Although G4S is growing its dividend, the pace is slow and when I think back to the firm’s trading problems around the time of 2012’s London Olympics I’m already feeling uncomfortable with G4S as a potential dividend grower for my SIPP.
Well-known investors such as Lord John Lee have it that we can tell a lot about a firm just by studying its dividend record and decisions the directors take around the dividend. To me, G4S seems cautious about its dividend, which suggests the directors could be cautious about the business, so I think we investors should be cautious too.
Cash, cash, cash
It takes cash to pay a dividend and during 2015 Legal & General’s cash flow slipped into negative territory. In other words, despite all the trading effort, cash flowed out of the business instead of flowing into it. It will be interesting to see how 2016’s performance comes in with regard to cash generation.
A large part of its problem with cash generation seems to be that the firm runs an investment portfolio to help cover policy liabilities, and investment losses appear to have occurred during the period rather than gains. That’s why firms like Legal & General in the wider financial sector are so highly cyclical, and it makes me nervous.
If financial markets plunge because of some macroeconomic event, share prices of firms such as legal & General will likely plunge, too. We can see how vulnerable the stock is to macroeconomic distress, or the perception of such distress, by looking at how the share price performed last year, at one point down around 43%. If you need further proof of the firm’s cyclicality, look at the depths the stock plunged to during 2008 in the wake of the credit crunch.
G4S, on the other hand, has a record of cash from operations that tends to follow and support profits. The trouble is that profits have been volatile.
I’ve seen enough
Legal & General’s inherent cyclicality makes the firm unsuitable for my long-term dividend growth portfolio within my SIPP. To me, cyclicals such as this are best traded by buying at cyclical lows and selling when profits and trading have recovered — before profits and the share price plunge into the next downleg. If I held it, I would more likely be a seller of the shares than a buyer now, despite the tempting dividend yield.
Oh… and G4S doesn’t make it to my SIPP either. Its trading is just too volatile.
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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.