Income portfolio initial screen

Income investing

Here we are looking to screen for companies that have a proven track record of dividend growth with an acceptable yield. As with the growth portfolio, this needs to be combined with a reasonable price, low financing risk and quality.  To achieve this I run the following screen:

A 1 year rolling yield of 3% - I consider this to be a reasonable target to start my search, too high a level and your search will contain only problem companies that may not be able to sustain the pay-out.

A dividend cover of at least 1.5x – this is the amount of times earnings cover the dividend and a cover of 1.5x allows for earnings to decline by over 30% and there still be sufficient profits for the current level of dividend to be paid.

A history of dividend increases for at least 8 years – This will eliminate companies that have cut or frozen their dividends over that time period.  With companies, that for whatever reason, have frozen or cut their dividends you run the risk of ceasing to achieve real returns, as inflation eats away at the pay-out.  The directors of companies with a track record of increasing dividends will take whatever action they can to ensure that the record is not broken on their watch. Companies that have taken the decision to cut or freeze their dividend will find it somewhat easier to justify this action in the future.

An EPS 1 Yr rolling growth rate of 5% or greater - we require some growth to continue with the dividend increases and an ideal level is above the level of inflation.

A maximum 1 year rolling P/E ratio of 15 – once again not wishing to overpay, this will produce a minimum earnings yield of at least 6.67%, a good margin of safety over my 3% yield target.

An operating margin of at least 5% - as with the growth portfolio, companies with high margins are able to weather economic storms better than low margin companies.  Low margin companies may have difficulty sustaining an increasing dividend pay-out.

Gearing of 75% or less – the same requirement as the growth portfolio, we do not want the bank and other debt holders competing with shareholders for the company’s cash.

A 5 year average of ROE of 15% - we want to screen for companies that have a reasonably long period of acceptable returns on equity. This is likely to demonstrate a company with a sustainable competitive advantage(s) creating a good economic moat (more about economic moats later).

Finally a market cap greater than £300m – these will be companies that have been around longer and if meeting the other criteria have some stability with respect to cash generation for dividend payments.

Although not part of the screen, much of the further analysis will be involved in assessing the quality of each company’s cash generation.