Investment Week – UK Income
04 February 2010
In an environment of very low base rates, sustainable yield is a highly attractive investment style. Dividend cover has been the best performing and least volatile style factor over the past year according to our quantitative model, the Matrix. This may seem counter-intuitive given the recovery nature of the market over the bulk of this period. However, it is understandable that investors remain selective, opting for companies that offer sustainable yield.
Our Focus on Change investment process allows us to identify improving situations that have not been fully recognised by the market. Even after the rally of 2009, we see a wealth of opportunities across the market cap spectrum, where there is potential for growing dividends and capital appreciation. In many cases, the dividend yield is well above the market yield despite dividend cover being solid.
One area of the market that scores highly on dividend cover is Industrials. The sector sold off aggressively in late-2008 on fears over capex cuts affecting sales. One example of an industrial stock that has been overlooked by the market is industrial printing equipment business Domino Printing Sciences. Having managed to deliver sales and earnings growth during the worst recession in 30 years, Domino has now shifted the focus onto maximising the gearing to economic recovery. We expect a pick-up in replacement demand as old kit that companies have put off replacing becomes obsolete. A new product range, whose advanced engineering and common platform will require fewer components, will reduce costs of production and so boost margins. At the same time, operational cost savings and weak Sterling have led to analyst forecast upgrades. Despite the strong fundamentals, the stock offers good value at 12x next year’s earnings with a very well covered dividend yield of 4.3%.
We are excited by the prospects for our fund, given the opportunities presented by such investments as Domino Printing Sciences. We are confident that our process – combining management contact, fundamental analysis and quantitative modelling – will allow us to identify many more such opportunities and so lead to continued out-performance.
Bull points
- Yield compelling in low interest rate world
- Continued preference for ‘quality’ supports steady income-paying companies
Bear points
- Risk that market refocuses on capital growth as recovery comes through
- Dividend growth may lag earnings growth as companies rebuild cover
Thomas Moore, Manager of the UK Equity Income Unconstrained Fund, Standard Life Investments
This article was first published in Investment Week on Monday 15th February 2010.
