Mellon on the Markets: Building a dividend portfolio

Inside the mind of the Master Investor: influential British investor, Jim Mellon, reveals his latest thoughts on the markets.

It’s been a busy old month, what with Longevity Week and in particular the Longevity Forum in London, the MoneyWeek Wealth Summit and a shareholder meeting for Juvenescence. Coupled with some stuff on Agronomics, it’s been exhausting and I am looking forward to a week of gentle book editing in Berlin. After that, I’m off to the US for two conferences – then the Christmas round of joy and (mostly) happiness!

At the MoneyWeek summit, and at our own company’s quarterly meeting in Berlin, I explained that I am becoming particularly keen on thematic investment, with the three major investible themes being climate change, clean meat and the modern agricultural revolution – as well as, of course, the biggie which is likely to affect everything −the science of longevity.

Climate change is hard, because returns are being compressed, but the other two should be included in everyone’s portfolio. As part of London Longevity Week, Master Investor held a sold out day on longevity, and they will be doing one on agritech and clean meat in the near future.

But while we wait for sufficient companies to become investible in these areas – and they will – we need to make some money for our daily bread.

Earning our daily bread

Regular readers will know that I favour dividend yielding stocks over internet-based growth stocks currently; that I disdain low yielding bonds; and that I am a big fan of gold and silver. Unless there is a collapse in earnings across the board, due to some massive economic recession (and although there are macro clouds, this isn’t likely in the short term), most big companies with juicy dividend yields should be able to maintain their payouts, and are therefore a good buy.

Janus Henderson, the fund managers, have pointed out that global dividends have continued to rise, even as earnings have stalled. Globally, they forecast that dividends will grow a shade under 9% in 2019, to £1.1 trillion – approximately a payout of 46% of total global earnings. This is a comfortable ratio but disguises some examples of companies where so-called dividend cover, which is the capacity of companies to continue paying generous dividends, is perilously close to being exhausted. In fact, in the UK, the ratio isn’t particularly wonderful, which is why investors have to be careful.

Companies with ridiculously high yields are usually (not always) stressed and likely to cut their payouts – or even get rid of them. Companies with excessively high debt are to be avoided, especially if the debt is keyed to adverse macro trends (eg to retail property).

This will narrow the field considerably – even amongst the biggest companies. It is instructive that over a quarter of FTSE 100 companies yield over 6%, indicating either massive mispricing of equities versus bonds, or something fundamentally wrong with the companies. Most likely, it’s a bit of both.

For our own part, we are gradually building up our dividend portfolio, with a mixture of UK and overseas shares. Webear in mind that many UK big companies get the bulk of their earnings overseas so are effectively international. It should also be noted that on holdings in US stocks, there is a withholding tax of 30% on dividends – on Japanese stocks it’s 15% −which should be taken into account when making your final cut.

Building a dividend portfolio

AJ Bell suggests that the FTSE 100 currently yields 4.8% and is covered about 1.6x, which is a little tight. This is a significant reduction in coverage over the past few years. But there are still safe havens with dividends of significance out there, and I will give you a few examples which I favour.

BP (LON:BP.) is one, as is Lloyd’s Bank. We are not going totally green any time soon and BP looks the best of the oil majors to me, with a near 6% yield. Lloyds (LON:LLOY) has a similar yield and with PPI almost behind it, and both a very strong balance sheet and position in the UK domestic market, along with almost no overseas exposure, I am a happy holder.

Delta Airlines (NYSE:DAL) in the US (with a very valuable frequent-flyer franchise business – selling points effectively) is cheap, well-run and although uncomfortable to fly on, a good place to park cash. Similarly, IAG (LON:IAG), owner of BA, is cheap and is at long last getting better planes and, hopefully, an improved service. Many is the time I have vowed to never fly BA again, only to have to trot back onto one of their aircraft due to a lack of viable alternatives. I’m not keen on long detours.

Marston’s (LON:MARS), the pub company, looks similar to Greene King (recently acquired) to me, and with a yield above 6% and surely the prospect of a takeover, it is an interesting one to hold. Other US holdings include GM (NYSE:GM) and Gilead (NASDAQ:GILD), the big drug company with a yield approaching 4%. I also retain a position in Avation (LON:AVAP), the aircraft-leasing company listed in the UK.

I think all of these, along with BT (LON:BT.A), Shell (LON:RDSA), British Land (LON:BLND) and Great Portland Estates (LON:GPOR) are useful ‘bankers’.No, you won’t get rich with them, but you should get a return that is significantly above inflation and a bit of capital gain thrown in.

Rio Tinto (LON:RIO) and BHP (LON:BHP) are excellent dividend yielders and I would hold them, as inflation is surely going to rise. But the main thing for inflation is – you guessed it – gold, and any opportunity to load up on it, its derivatives or anything related to it that isn’t run by fraudsters – well, I’d go for it.

I would also load up on sterling, particularly against the US dollar. Boris will romp the election and the pound will go up 5% overnight.

Happy Hunting!

Jim Mellon