28 Aug 2019

Anyone who cares to investigate can discover that the equities that you probably own directly or through your pension scheme are equitable only with each other. Benjamin Graham, the so-called father of modern investing, called them “common shares” which is a better clue. When a company is wound up this typically means that it has run out of money and run out of people who will lend or give it more cash. Equities represent any surplus assets that are left when all other creditors have been paid off. Every other creditor ranks above the owners of the common shares. First are secured creditors like banks or bondholders who have lent money on fixed terms. If the company defaults on those terms it can be forced into formal insolvency, though sometimes the secured creditors will accept equity in return for a further cash injection, if they judge that their best chance of getting their money back in the end is to keep the business going. In those circumstances they will be issued shares on such favourable terms that existing equity investors are diluted to the point of worthlessness. This is happening now in the case of Thomas Cook. After secured creditors have been paid in full, anything left goes to so-called preferential creditors, including employees, and then to the luckless trade creditors and HMRC. You can infer that common shareholders will usually be completely wiped out. Unsurprisingly, people who invest in equities very rarely think about the risk of insolvency and losing all their money. We all dream of the day when the theoretical value of those surplus assets explodes upwards. Bond holders may get their money plus interest back but as Benjamin Graham pointed out many decades ago, common stocks have “a far better record than bonds over the long term past”. It has widely been accepted as a fact that equities are the answer for a long term investor. Cautious share owners look for sustainable dividends that can rise as the company grows; the more optimistic hope for rising share prices as well. Those are the two elements that drive the long-term performance of common stocks observed by Graham. But stock market investors...

30 Mar 2018

In my report on Q4, I wrote that “for the third successive quarter, the markets were mysteriously calm.” The calm was disrupted in Q1 for sure: the main UK indexes fell by between 6% and 8%. The German DAX was -6.3%. Supported by a falling dollar, the US markets, though volatile, did better with the DJIA -2.5%. I hinted before that the stock markets might be vulnerable to rising interest rates or, more specifically, rising bond yields. In February it started to look as if this was happening; the US 10 year treasury yield had risen from 2.40% to 2.94%; but by the end of the quarter it was back to 2.74%. A similar pattern played out elsewhere. The 10 year gilt yield rose from 1.20% to 1.69% but ended the quarter back at 1.34%. It would seem that the wait for inflation goes on. Aside from the usual nonsensical white noise about “uncertainty” it is hard to escape the conclusion that the stock market is truly concerned about the ability of large corporations that feature in our lives daily to invest capital, service debt and pay dividends. Here is your day described in terms of dividend yields: you are woken by the ringing of the house phone (BT: 6.8%) and switch on the light (National Grid: 5.6%); you turn up the central heating (Centrica: 8.5%) and clean your teeth (Glaxo: 5.7%); you decide to go into town but your car has no petrol (BP: 6.0%, Royal Dutch Shell: 5.8%) and needs a new rear light (Halfords: 5.4%) so you decide to take the bus (Stagecoach: 9.0%, Go-Ahead: 5.8%); you do some shopping in Currys PC World (Dixons Carphone: 6.0%, Vodafone: 6.7%) and M&S (Marks & Spencer: 6.9%) before treating yourself to a pub lunch (Marstons: 7.4%, Greene King: 7.0%). Is it the end of the world as we know it? Yet, against this rather sinister background something quite different has been happening. Companies who want to buy each other seem to like these prices very much. On 22 December GVC announced its intention to buy Ladbrokes plc. On 17 January, Melrose bid for GKN; on 30 January UBM agreed to be taken over;...

21 Sep 2015

Perhaps the most pertinent question for UK stock investors today is “can I trust those high dividend yields?” Glaxo has pre-announced that it will maintain its dividend at 80p per share this year and next year. That’s a yield of 6.2%. Royal Dutch appears to yield 7.5% on the basis of paying $1.88 (c.120p) also “guaranteed” for 2015 and 2016. If these companies can be relied on to continue these pay-outs, it matters little whether Janet Yellen dares to raise the federal funds rate from irrelevant to insignificant or indeed whether Mark Carney goes mad and does the same with the bank rate.  Here is what I previously wrote about the interpretation of high dividend yields. Shares that yield 5% The market does not like these companies. They are seen as unreliable. This may be because there are external threats that are beyond the power of management to prevent or mitigate or it may be that management is simply mistrusted. It might also be the case that they are mature businesses that are, rightly or wrongly, thought to be approaching the end of their life-cycle.   Shares that yield 6% The market does not trust the dividend. It expects it to be cut (or “rebased”, in modern corporate terminology). Naturally I agree with every word of this and everything that follows should be seen in the context of those comments. I will briefly discuss Glaxo and Royal Dutch before moving on to some humbler companies. There is a summary at the end. GLAXO           Price:  1296p                    Hoped for dividend:  80p                       Yield: 6.2% Glaxo is showing off by paying a bonus 20p in respect of Q4 (year-end March 2016). This seems to me an unnecessary answer to the sceptics who would anyway be confounded merely by flat progress. People dislike Big Pharma about as much as they dislike Big Tobacco and they both look like industries that spend a fortune on lobbying. Glaxo needs to generate $3.8bn of free cash flow to pay its 80p dividend without adding extra debt (nearer $5bn this year with the bonus). In 2014 it made free cash flow of $5.5bn; in the year to March 2015 free cash flow was...