Dogs of the Footsie: 9% return this quarter from shares alone

Money Observer’s Dogs are having a diamond 2017: over the first nine months of the year, they have produced a sparkling 9 per cent return from share price alone, and 14.4 per cent with dividends included, compared to 5.4 and 9 per cent respectively for the FTSE 100 index.

Regular readers will know that our Dogs are corporate rather than canine, made up of 10 unloved companies from the FTSE 100 index as measured by their dividend yield. Compiling the portfolio does not require technical analysis or investment prowess, but simply involves selecting the 10 companies with the highest historic yield, based on past dividend payments (which can be obtained using a screening tool on websites such as Interactive Investor or Digital Look). Divide your investment equally between them and hold for one year.

Crude it may be, but it has proved remarkably successful. If the rest of 2017 is as good as the first nine months, it will mean that the Dogs have romped home ahead of the index in four of the past five years, and seven of the past 10.

The logic behind this is straightforward: a high dividend yield can be a sign that a company is unloved, either because it has been through a bad patch or because it is in a sector that is out of favour with investors. In such situations, the shares can often fall well below their fair value and will bounce back strongly when sentiment changes. In the meantime, patient investors will be rewarded with generous dividends underpinning the high yield.

Of course, a high yield can also indicate that the market expects the dividend to be cut – something which does frequently happen with Dogs companies. While that is obviously not good for income, it is not necessarily all bad news, as a company’s shares can often rebound when anticipated bad news, such as a dividend cut, actually happens.

No dividend cuts

There have been no dividend cuts among our portfolio so far, but the performance of the constituents has varied. Romping home in first place is Persimmon, the housebuilder, with a 52 per cent return including dividends, reflecting the huge boost to the sector from the various government schemes aimed at helping people onto the housing ladder. The two financial companies – Legal & General and HSBC– are some way behind but, with total returns of more than 19 per cent, have still produced more than twice the 9 per cent return for the FTSE 100 as a whole. That has more than compensated for the losses suffered by two of the portfolio – utility SSE and Royal Mail. Overall, seven of the companies outperformed the index over the nine-month period.

-Global dividend payments surged by 14.5 per cent in Q3 of 2017

Those who choose to follow the Dogs must not attempt to add a layer of analysis on top: the strategy requires investing equally in all 10 companies and holding them for a year. The portfolio is thus large enough so that, even if a few of the constituents perform badly, the portfolio as a whole can still do well. Selection should be based on historic yields and only companies that have actually announced a dividend cut should be excluded, not those where the market is predicting one that has not actually happened.

As is required by the strategy, we are not making any changes to our portfolio at the moment – we will start a new portfolio for 2018 at the next update. Those who want to start now, however, can either select a portfolio themselves or use the companies shown in the box above, which are the current top 10. The current portfolio differs from our 2017 one by just two companies, with BT and GlaxoSmithKline– which have both featured in previous Dog years – replacing Persimmon and Capita, which have been pushed down the yield table by a rising share price.

The success of the Dogs strategy underlines the importance of dividends to total returns, something that has long been accepted by investment theorists. The past few years have been exceptionally good for income investors, with robust dividend growth across many sectors. Capita Asset Services predicts that, for 2017 as a whole, dividends will grow by more than 11 per cent – a very healthy return given that inflation is just 3 per cent, albeit on a rising trend, and that it is all but impossible to get even 2 per cent from holding cash.

That growth is driven by two key factors – the devaluation of the pound following the Brexit vote last year, which has boosted the sterling value of dividends from companies like HSBC, BP and Shell (which pay dividends in dollars), and a dramatic recovery in the fortunes, and thus dividend payments, of the big mining groups. Capita estimates in its Dividend Monitor that mining companies accounted for two-thirds of the rise in dividends in the first nine months of the year, and says that at constant exchange rates, growth in the full year will be 8.5 per cent. 

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