10 best stocks for blend of income and growth
2016 was a year when swingeing dividend cuts and zero growth were expected to inflict pain on income investors. But with the devaluation of sterling after the EU referendum, the result was rather different. Incredibly, fourth-quarter payouts hit record levels - up 11.7%. That was undoubtedly good news, but the true picture on dividends shows that investors should tread carefully.
Full-year dividends in 2016, including special one-off payments, rose by 6.6% to £84.7 billion. But it was masked by the fact that a huge slug of UK dividends are paid in dollars. As a result, the figure was flattered by the fall in the value of sterling and higher than average one-offs.
According to Capita Asset Services, which tracks UK dividends, £4.8 billion of the £5.2 billion headline increase was down to the weak pound. In other words, there was scant evidence of UK companies paying more in dividends because they were earning more.
Strip out the currency effects and £6.1 billion of one-off specials, and underlying dividends only grew by 2.6% last year. As it stands, real dividend growth is hard to find.
The watchword for 2017 is "uncertainty". Special payments are forecast to fall, but the lower rate of sterling is expected to boost the figures again. Capita reckons we'll see underlying growth of 7.5% to £84.4 billion.
What these figures show is that investors looking to equities for income should also take capital growth (through rising share prices) equally seriously. Combining income and capital growth is nothing new in investing but the two approaches are often needlessly separated. It is possible to get both.
Some of the highest profile growth investors - those that look for big gains in smaller, faster moving stocks - also have an affection for dividends. Among those names are the likes of Robbie Burns, Jim Slater, Peter Lynch and Philip Fisher.
Combining growth and income
One strategy that takes the essence of this growth-plus-income approach has performed incredibly well in recent years. We've visited it before in this column, but its seemingly inexorable rise merits a routine mention.
It's a strategy that looks for companies that are having their earnings forecasts upgraded by analysts, that have above average profitability and below average valuations plus strong yields. Tracking by Stockopedia shows a return of more than 220% over the past five years (and that's before dividends).
It must be said that those performance figures are produced in lab conditions. They don't take into account trading costs, and the portfolio is refreshed on a quarterly basis. But even so, as a test of what can be achieved with this combination of growth and income factors, it's a pretty compelling starting point. Here's a snapshot of how the screen currently looks:
The list starts with recruitment group Gattaca (GATC), where the shares have been under pressure and the yield has risen to over 7.5%. At that level, market watchers tend to worry that the yield might be a trap and the dividend may be cut.
Yet, with all these companies, above-average yields are matched with at least some degree of improved earnings forecasts. They range from very large companies like the housebuilder Bellway (BWY) to small-caps like building services group T Clarke (CTO) and aviation services company, Air Partner (AIR). In between, you see firms like the real estate investment trust Newriver (NRR) and retailers like N Brown (BWNG) and Games Workshop (GAW).
This blended approach to growth and income has proved to be potent in recent years. At a time when dividend growth is hard to come by, this strategy has excelled. But with any approach involving small-caps things can go wrong, so detailed investigation is very important.
Likewise, very high yields can be a signal that the market no longer believes that the payout is sustainable. Striking a balance between these risks by looking for signs of profitability, an improving outlook and below average valuations could help in the search for growth companies with an added dividend kick.
Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.
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It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.
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About the Author
Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.