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Income Investor: RSA, dividend cuts and when to sell
Dividend cuts from RSA and Morgan Sindell highlight the need for income investors to do their research and diversify their holdings.
Another day, another dividend cut, it seems. First for my portfolio it was Morgan Sindall (MGNS.L) and then it was RSA Insurance (RSA.L), with a crashing 14% share price fall on the day of the announcement.
Morgan Sindall is in the UK construction sector, specialising in infrastructure, affordable housing, 'fit out' (for offices and shops), urban regeneration and property investments. Their preliminary results disappointed and unveiled a dividend cut. RSA, the general insurer behind More Than, yesterday ‘rebased’ its dividend (ie, cut it by a third) when it announced its full-year results.
Putting aside the specifics of these two companies, there are some general themes that may be relevant to other income investors.
High yield = high risk
One half of my income-oriented portfolio targets good quality shares that have attractive dividend yields. Selecting the shares is not easy: because they are – by definition – ‘high yield’, Mr Market has already indicated that there is something about the company he just does not like. The high yield means the shares have fallen, indicating investors' doubts over whether the dividend is sustainable.
A good rule of thumb is to be wary of anything that is more than twice the average yield of the market (so currently anything more than 6-7%). You should see the high yield as a flashing amber light, warning you to do your homework. Your job is to find out what the potential problem is and to make your own assessment of how likely you think it is to go bad.
At the very least you should look at the latest company report and accounts and try to read between the lines. In particular you will need to look at cash flow, dividend coverage, trends in debt and profitability, etc. The dividend trend and stated policy will also be of particular interest, although this can sometimes be massaged. Todd Wenning’s Dividend Compass is a good example of the kind of detail you can go into.
Even being careful, you might get it wrong, as I have with these two. But that is the nature of the beast: high-yield dividend investing is arguably a form of contrarian value investing. And when a dividend share goes bad, there is a ‘double whammy’: the dividend is cut and the share price falls. It’s a bit like walking a tightrope without a safety net.
When to sell?
Many income investors will sell on a dividend cut. But another common factor of these two dividend-disappointers is that I will continue to hold them (for now). I am still above water on the price and the forward yield is likely to be around 5% for both. They are still good businesses; as long as the dividend yield remains acceptable I will only sell if the business model looks shaky.
These results highlight the need for diversification in any portfolio. In my case the fixed-income half of my investments is steady, although starting to come off its valuation highs. The big problem for dividend shares is the continuing depression in the UK and European economies. Any company that is looking primarily at these markets is likely to suffer over the coming months. The 'Great Rotation' is likely to rotate to somewhere else.
Which is why, for the last couple of months, I have been trying to diversify away from Europe, whilst – unfortunately – watching my pounds quickly lose value.
If you've enjoyed this article, why not visit DIY Income Investor's blog. The views in this article are the author's own, and do not constitute advice.
You can see previous articles by Income Investor on the 'Citywire Money guide to income investing'.
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by Gavin Lumsden on Oct 23, 2016 at 00:01