Investors seem to be “looking a gift horse in the mouth”, according to FE Alpha Manager Nick Train (pictured), who says real dividend growth is as high as he can ever remember throughout his 30-year career. 
The manager of the five crown-rated Finsbury Growth & Income trust says the ongoing digitalisation of companies will provide a significant tailwind for many firms over the next decade.
He also says there are many investable companies with high operating margins and compelling growth stories, yet recent polls suggest that investors are struggling to remain optimistic.
“Currently, real dividend growth is as high as I can ever remember in my entire career and I do generally feel there’s a sense that investors generally are looking a gift horse in the mouth,” Train said.
“Inflation is extraordinarily low but the corporate sector is, by historic standards, delivering really quite robust dividend growth.”
Finsbury Growth & Income, which has grown from £16m to more than £1bn in size over Train’s 17-year tenure, boasts a stellar long-term track record.
Over the last decade, for instance, it has achieved the highest total return within the IT UK Equity Income sector. While its average peer and FTSE All Share benchmark have achieved respective returns of 54 and 69.82 per cent over this time frame, the trust has returned 182.41 per cent.
Performance of trust vs sector and benchmark over 10yrs
Source: FE Analytics
What’s more, had an investor placed £10,000 into the trust a decade ago, they would have received £3,266.67 in income alone.
However, the trust struggled to beat its benchmark in 2016, underperforming the FTSE All Share by 4.17 percentage points with a total return of 12.58 per cent. It has since bounced back though, having doubled the performance of its benchmark year-to-date.
“I’m in the performance business and we all know the reality of it. The reality is the single most important year in your track record is always last year, however much we like to be disgruntled about that, that’s what clients are focused on,” Train said.
“The truth is, I underperformed last year and I’m sorry about that, Michael Lindsell and I really dislike underperforming over any period; we just have to hope that the returns of 2017 can be sustained.”
Ironically, the manager says the single holding within the 25-stock portfolio that has caused him the biggest heartache this year is one of the holdings that outperformed in 2016.
Multinational publishing and education company Pearson hit the financial headlines earlier this year after it issued a profit warning and announced plans to slash its dividends, which was the result of weak sales in its key North American educational market.
Year-to-date, the struggling stock is down 17.96 per cent while its FTSE 100 index has returned 3.22 per cent.
Performance of stock vs index in 2017
Source: FE Analytics
“It is really mortifying for me and, to a degree, for Lindsell Train as well as a broader business. We hold it across a number of mandates,” Train explained.
“It’s particularly mortifying because, again, to be totally transparent and truthful, we’ve not really decided what an earth we ought to do with the investment yet. We know we ought to either sell it outright or double up, it’s just that seems quite tough call.”
Train and the team met with Pearson five weeks ago, whose finance director pointed out that 68 per cent of the firm is already in digital services, it has more paying digital subscribers in the US than its competitors combined, and that it now has a partnership managing online degree courses with 45 per cent of universities across the globe.
“Most people will acknowledge that, if Pearson could succeed in its stated strategy of becoming the world’s premier digital education services company, its profitability would improve and the rating would probably improve as well,” he added.
One of the most significant events for Finsbury Income & Growth so far this year, however, has been Heinz Kraft’s failed £120bn bid for its largest holding Unilever.
The outright rejection last month was reflected positively in the food and beverage firm’s share price, and Train agrees the merger would have been of greater benefit to Kraft Heinz than it would have been to Unilever.
“Unilever’s dividends have compounded at 8 per cent per annum since 1962. That is more than half-a-century of 8 per cent compound dividend. It doesn’t get much better than that, ever. Thank goodness that transaction never got anywhere near getting off the ground. At least people acknowledged what this dividend machine can do,” he continued.
“For us, it confirms that today we are slap bang in the middle of the biggest merger and acquisition boom in financial history. 2015 was the biggest year ever for global M&A, 2016 was the second-biggest ever for global M&A.
“So far in 2017, over $2trn of M&A activity has been proposed and that’s running at 70 per cent higher than the same stage as this time last year. We expect a lot more of this kind of activity and that £120bn ticket put on Unilever demonstrates that nothing is too big.”
Elsewhere in the portfolio, Train says he is particularly pleased with the development and progression of Hargreaves Lansdown, which is the trust’s seventh-largest individual portfolio weighting.
Aside from four property companies and investment services group 3iii – all of which the manager says are highly-leveraged and potentially include disposal of profits in their numbers, he says Hargreaves Lansdown is the most profitable FTSE 100 company based on average three-year operating margins.
“When a trading company with an operating margin of 60 per cent grows, and Hargreaves Lansdown does continue to grow, a great deal of value is created for the owners of the company,” he explained.
“My favourite fact of 2016 is that, five years ago, the total running costs of Hargreaves Lansdown expressed as a percentage of assets under management was 32.5 basis points. Today, five years later, the total running costs of Hargreaves Lansdown expressed as a percentage of its assets under management is 16 basis points.”
“In other words, the cost of running the company has halved over the last five years. That’s a result of assets under management increasing of course, but it’s also a result of the increasing efficiencies the company is deriving from becoming more and more digital. As it digitises, the cost of running itself collapses.”
Train says there is a quote that particularly resonates with him when it comes to investing and the rise of digitalisation.
It is from former Intel CEO Andy Grove, who said: “I have been quoted saying that, in the future, all companies will be internet companies. I still believe that. More than ever, really.”
“We meet quite a lot of companies and, almost without exception, every company we meet with wants to talk with us about digital. They want to moan about the way that digital is disintermediating parts of their business, that was a big part of the conversation with Pearson,” the manager explained.
“But at the same time, everyone wants to talk about what digital is doing to transform their productivity and their potential for margin enhancement. And, maybe more importantly, their prospects for growth in terms of enhancing products and services and reaching more customers.”
Train says this is directly relevant to many holdings within the Finsbury Growth & Income portfolio aside from Hargreaves Lansdown, from the fact Sage now processes one billion payslips per year, to the fact that Daily Mail & General Trust’s Mail Online’s discrete visitor numbers are growing by 20 per cent per annum.
“Dividend growth at the start of 2017 is strong but I am interested in dividend growth for 2027,” he concluded. “It is going to come from these sorts of ideas and the progression being made by these companies.
“I remain an unrelenting and unrepentant bull, there is far too much pessimism in the market; it’s just profoundly wrong.”
Finsbury Income & Growth is trading on a 0.4 per cent premium and is 2 per cent geared. It yields 1.9 per cent and has an ongoing charges figure of 0.74 per cent.