Cash-compounding companies for your portfolio

While a significant proportion of funds in the UK Equity Income sector invest predominantly in the same defensive large cap dividend-payers, Hugh Yarrow, manager of the £6.5m Evenlode Income fund, says he looks for businesses that are light on assets and light on debt, but high on intellectual property and repeat business.

"Our investment strategy centres around what we call 'cash compounders'. These are businesses with durable brands, high market shares and lasting customer relationships which offer a high return on equity and have very low levels of debt," said Yarrow.

"We don’t have a bias towards large or small companies but will hold companies that have the ability to generate repeat business with considerable pricing power. Capital discipline is really important in this sort of environment. The biggest risk for the equity income investor is when the management of a company does not value the share holder," he added.


Diageo, dividend yield 3.6 per cent

"This is a stock which has never been particularly fashionable but the fundamentals of the business are creating the cash compounding effect we are after."

"Diageo owns brands like Johnnie Walker, Guinness, Jose Cuervo, Captain Morgan and Smirnoff. These are being consumed by aspirational middle classes in China, south-east Asia and Africa."

According to data from FE Analytics, just two funds list Diageo in their top-10 holdings: Liontrust UK Growth and Schroder ISF Global Equity Alpha.


Reed Elsevier, dividend yield 4.7 per cent

"Reed’s management spent £8bn on acquisitions trying to grow the company. A rights issue was needed to raise the capital and consequently the share price came down and the stock became unpopular."

"From 2009 the company has been under new management who have a record of good capital discipline. These guys are focusing on organic growth based around the original business model."

"One of the most attractive things about Reed is that they are successfully migrating their business online. Businesses and academics are choosing to access documents via the web rather than buying expensive books."

"This suits Reed because they are able to charge repeat subscriptions and have fewer assets and lower costs. This is one of the driving features of our cash-compounder strategy."

Data from FE Analytics shows that 41 funds list the publishing company in their top-10, including the £799m JOHCM UK Opportunities fund.


WS Atkins, dividend yield 5.5 per cent

"Atkins is a market-leading UK engineering consultancy. You will see their logo on the back of road signs when you are stuck in traffic on the motorway."

"The company grew its dividend at more than 5 per cent a year and held earnings throughout the downturn. We like it for its asset-light business model. We believe that energy and infrastructure challenges will create long-term demand growth."

Schroder UK Mid 250 is the only other fund to have Atkins in its top-10.


BSkyB

"This is a new holding that we’ve built up in the wake of News International pulling their bid. Sky has over 10 million loyal customers who subscribe and they’ve proved very resilient during the recession. The largest growth is coming from cross-selling high definition and broadband packages to existing customers."

"BSkyB have increased their dividend by 20 per cent and have recently announced a £750m share buy-back programme which shows they care about shareholder value. BSkyB is an unusual stock for an equity income fund but it is currently yielding 3.6 per cent."

According to data from FE Analytics, 13 funds list BSkyB in their top-10, including Fidelity Special Situations and Kames UK Opportunities.