Keen on cheap, high yielders

In the past year or so, my own inclination – and the advice I have had from my IFA – has been to “buy on the dips” in the equity market. But the dips have been few and far between. So I haven’t quite got round to it with any great enthusiasm, with the result that my portfolio is still around 11 per cent in cash.

Outside of my pension fund and Sipp, where I did recently reduce the cash holdings with positive results, and some additional investments into my coin collection, equity investments I have made recently have tended towards the higher yielding end of the spectrum.

The three holdings I have added – National Grid, Merchants Trust and Local Shopping REIT – are all now in profit and have collectively more than made up for a hefty loss incurred in a premature investment in BP at the height of Gulf of Mexico oil well debacle.

Given the success of this policy, I am wondering whether to do more of the same. The problem is that many of the stocks with decent yields and respectable cover fall into the insurance category.

Catlin, with a cover of 3.6 and a projected yield of 7.8 per cent, might ordinarily seem attractive, as might Novae (cover of 3.3; yield of 6.3 per cent) or Beazley (2.5 and 6.4 per cent) or even Aviva (2.3 and 6.4 per cent). But I am cautious about investing in this sector. Despite having worked for two insurance groups, this is neither an area that I pretend to understand in any depth, nor one where I have had any conspicuous investment success.

Instead, I am turning to companies that appear to be casualties of the recent public spending review, but where the share price action may have been excessively negative.

One obvious candidate here is Eaga, the energy efficiency business. It derived a considerable amount of revenue from the government’s “warm front” scheme, designed to foster energy efficiency measures in poorer households. Funding for this scheme has been cut to a third of its previous level. I make no further comment on the trivial amount of money that this rather mean-spirited decision has saved.

While revenue from the Eaga division, of which the “warm front” initiative formed a big part, represented more than half of the company’s total revenue, in profit terms it was less important, contributing only around a fifth of operating profits. Nonetheless, while it is possible that Eaga may be able to cut costs to reduce the impact of the lost revenue, there is little doubt that profits will suffer. However, this is not really the point. The question with high yield investing is whether or not the dividend that generates the yield is secure.

Here, one can perhaps be more confident about Eaga. The payout is currently covered three times. Even if profits were cut in half, the cover for the dividend, though not generous, would still be adequate. The cost of the dividend, at £5.7m, is not large in the context of a company that generated £26m in operating cash flow last year and which, in addition to the dividend, spent £4.8m on share repurchases.

Also, the employees are large shareholders, both directly and through the employee share trust, which also argues against a cut. Finally, the group has no borrowings and substantial cash balances. All of which makes a near-halving in the share price in the past few weeks look like something of an overreaction. So does this add up to a risk worth taking? I haven’t made up my mind yet.

Peter Temple is an active private investor writing about his own investments. He may have a financial interest in any of the companies and trading strategies mentioned.

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