UK investors can find dividend-paying stocks further down the market cap scale for those brave enough to look outside of the FTSE 100, according to Lowland Investment Company managers James Henderson and Laura Foll.
Income concentration has becoming more of a concern for UK investors given the large proportion of dividends paid out by a handful of blue-chip companies.
While the top 100 companies remain the largest payers of dividends, paying out £28.6bn in Q2 compared with £4bn from mid 250 companies, according to data from Capita Asset Services. However, mid caps have seen strong growth in dividends more recently.
Source: Capita Asset Services
The managers of the UK-focused trust invest across the market cap scale and have developed a number of methods for counteracting income concentration. These methods include diversifying the income stream through small and mid-capitalisation stocks, which they said are “ordinarily unloved by the income seeking portfolio manager but with the potential of being great yield stories”.
“The small- and mid-cap space is usually reserved for the growth investor – those seeking above average levels of earnings growth, which they believe will translate into strong share price returns,” the pair noted. “Large caps have tended to be more associated with income seekers.”
“The income rationale behind larger businesses is that strong and stable companies with entrenched market positions and experienced management tend to be very focused on creating shareholder value and therefore delivering steady or rising levels of dividends.”
“Because of their lack of liquidity, mid- and small-cap stocks are often under-researched by analysts,” the pair said. “Less coverage means less information feeding into the stock market and the share price, giving the savvy investor a greater chance of uncovering undervalued stocks with attractive yields.”The IT UK Equity Income trust, which aims to deliver higher than average growth of capital and income over the medium-to-long term, currently has a yield of 3.25 per cent.
Below the managers highlight some examples of high yielding stocks from lower down the market-cap scale.
Redde
The first stock identified by the managers is Redde, a specialist accident management company providing a range of legal and insurance services.
Performance of company YTD
Source: FE Analytics
“When your car breaks down or you’re involved in an accident, a few things are crucial in rectifying your situation: you need to get the car fixed and pay any legal or medical expenses that may need covering,” the managers said.
“You also need a replacement car for the interim. Redde assists the insurers with a few of these jobs - running fleets of courtesy cars and operating repair garages. “
“The business – around £450m in size – is proving to be a success: increasing market share, which in turn is resulting in strong earnings growth and dividend growth. Currently it’s yielding 6.6 per cent.”
Moss Bros
Suit and formal menswear company Moss Bros is the second pick by the manager duo. The company was founded in 1851 and has 129 stores around the country.
In its most recent trading update in May, the firm announced total sales for the first 15 weeks from 29 January had increased by 3.7 per cent, year-on-year.
Performance of company YTD
Source: FE Analytics
“Moss Bros leads the pack in the UK for branded suits. Its journey since the financial crisis has been one of improvement and change,” noted Henderson and Foll.
“Years of underperformance made way for new management and a shake-up of the product range, disposals of non-core assets, and store refurbishments. The changing nature of the competition also helped – the quality of suits in rivals M&S and Next has slipped.
“All-in-all it is a niche and profitable business with above-average retail sales growth relative to its marketplace and a healthy dividend pay-out, which is propped up by a strong net cash balance sheet in the event of a downturn. It’s worth about £100m and currently yields 6.1 per cent.”
McColls
UK convenience store and newsagents group McColls is the pair’s final pick. The chain was founded in 1973 and had revenues of £504.8m, according to its most recent interim results.
The group has more than 1,290 convenience stores and 358 newsagents, following integration of 298 stores acquired from Co-op.
Performance of company over 1yr
Source: FE Analytics
“Head down to your local shops and you might notice a McColls convenience store or newsagents, the pair said. “They’re a growing presence, at around 1,400 stores. Convenience stores are one of the higher growth areas of the food market with less cost pressures than their supermarket cousins.
“Recently, management have wrapped up a very good deal for the business – buying 298 stores from Co-op, enabling them to exert much greater buyer power and cost savings on the goods purchased for their stores.
“The product range has also improved over the past five years and they’ve been gradually switching the mix from lower margin tobacco-driven newsagents to higher margin convenience stores with fresh produce.”
They added: “The business is valued at around £90m. Its current yield is 5.1 per cent.”