The RIT High Yield Portfolio (HYP) – Adding GlaxoSmithKline

I’ve now been building my High Yield Portfolio since November 2011.  A reminder of my previous purchases:

• On the 28 November 2011 I purchased AstraZeneca (LSE ticker: AZN), Sainsbury’s (LSE ticker: SBRY) and SSE (LSE ticker: SSE).
• On the 21 December 2012 I added Vodafone (LSE ticker: VOD).  To avoid all the Verizon Wireless disposal fun and games I subsequently sold out on the 21 January 2014 and then repurchased the new VOD on the 30 April 2014.
• On the 11 October 2013 I received 227 shares as part of the Royal Mail Group IPO (LSE ticker: RMG).  I didn’t consider it a HYP purchase at the time (and still don’t) but simply the closest thing to free money I’ve come across in a long time.  The tax payer really was fleeced on that one.  It sits within my HYP as it is the closest match within the different portions of my portfolio.
• On the 03 March 2014 I then added HSBC (LSE ticker: HSBA)
• On the 30 June 2014 I added Pearson (LSE ticker: PSON) and Royal Dutch Shell (LSE ticker: RDSB).

The experience continues to be positive with the HYP as of Friday (excluding the GSK purchase) sitting on a trailing dividend yield of 4.6% compared to the FTSE 100 dividend yield of 3.3%.  At the same time the HYP is also outperforming the FTSE 100 from a capital growth perspective.  Year to date capital growth of the HYP is down 0.6% compared to the FTSE 100 which is down 1.0%.  Since inception the HYP has grown 35.4% compared to the FTSE 100’s 25.7%.

Wealth Warning: I don’t know if long term this HYP strategy will work.  There is every chance that a simple diversified portfolio of lowest expense index trackers that are invested tax effectively will in the long term outperform this strategy.  Only time will tell. 

Buying GlaxoSmithKline

So with hundreds of shares to choose from I grabbed GSK on Friday.  Let’s review why by sharing my usual selection criteria.  At the same time let’s also have a quick look at how HYP’able my current holdings also look today.

1. Is the business model simple to understand?

The first criteria is qualitative.  I want to understand how the business I’m buying makes its revenues in less than 10 seconds.  GSK and its brands hardly need an introduction.  They are a global pharmaceutical and healthcare company developing and supplying medicines to help people do more, feel better and live longer.  They make everything from Ventolin which any asthma sufferer will likely know well, through remedies such as Beechams Cold & Flu and onwards to day to day brands such as Macleans toothpaste.  They even own the Horlicks brand.  This is simple to explain and understand so meets my first criteria.

2. Large and in non-cyclical industries.

GSK sits within the FTSE 100 so meet the large criteria.  Whether or not we are in recession people still need medicines and products such as toothpaste, paracetamol and cold & flu tablets.  So this criteria is met.  Of course many of GSK’s products are under attack from other brands including more and more generics as products come off patent.  Additionally, GSK seems to have more than its fair share of corruption scandals and I’m not a big fan of the board, in my opinion, trying to hide the real story by always talking about core profits which excludes costs such as legal costs and development costs which don’t sound very much like one offs to me.  But hey is any company perfect?

3. A range of industries

AstraZeneca is from Pharmaceuticals & Biotechnology, Sainsbury’s is a Food & Drug Retailer, SSE is an Electricity Utility, Vodafone is a Mobile Communications provider (although I consider them as a Communications Utility much like a Water, Gas or Electricity Utility), Pearson is Media and Shell is Oil and Gas Production.  GSK is my first duplication of an existing industry - Pharmaceuticals & Biotechnology.  I came close to adding Tate & Lyle which would have bought Food Producers and Processors into the mix (a better match for this criteria) but the GSK dividend yield of 5.5% vs TATE at 4.3% was just too tempting in the current market.  Only time will tell if it was a good move.  So a small diversion but generally I’m not far off this criteria.

4. Dividends payouts that are above that of the FTSE 100

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I am looking for shares with dividend yields somewhere between the current FTSE 100 yield of 3.43% and 150% of the FTSE 100 yield.

Today 3 of my 7 current shares are now over 150%.  GSK is also slightly over the Acceptance Criteria on 159%.

5. An unbroken history of continually increasing dividends plus dividends increasing at a rate equal or greater than inflation

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My acceptance criteria under this metric are that the dividends over the medium term must increase at a rate equal to or greater than inflation.   Ideally, for at least the last 5 years dividends this will be year over year increases.

5 of my current 7 have increased dividends at a rate faster than inflation over the medium term.  HSBA sinned badly on this front with a reduction in dividends of 23% but over the last 4 years they are well ahead of inflation with a 44% increase vs inflation at 16%.  RDSB is a  laggard following a few years of a sticky $1.68 dividend although in the 2 years since the un-sticking they have increased by 7% compared with inflation at 6%.  GSK passes this criteria with flying colours having 5 year dividend increases of 37% vs inflation at 19%.

6. Dividend Cover

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My acceptance criteria requires a ratio of greater than 1.5 for all HYP type shares except utilities where I think that greater than 1.25 is ok.  I accept a lower Dividend Cover for good utility companies as their earnings should be some of the most consistent with little to no cyclicality.  I also don’t like too high a Dividend Cover as I think this encourages CEO’s with delusions of grandeur to run off and make over priced acquisitions, or worse, use the profits not paid as a dividend to buy back the companies own shares thereby maximising their bonuses.  All of my current HYP shares meet the criteria.  GSK is slightly under at 1.4.

7. Operating Cash Flow to Dividends

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Companies through ‘creative accounting’ can make their earnings look good, hence make Dividend Cover look good.  Therefore while I look at Dividend Cover, I also set a criteria on Operating Cash Flows compared to Dividends.  The criteria is greater than 2.

6 of my current 7 meet the criteria.  PSON last financial year was a sinner by not having sufficient cash flow to cover dividends.  GSK don’t quite meet my criteria but aren’t far off at 1.9.

Conclusion

I now own 8 of my 15 to 20 HYP shares.  Using my acceptance criteria the previous 5 still look like reasonable HYP share choices.  I’m also reasonably happy with GSK.  Of course I’d like more cash flow and dividend cover but I’d probably actually prefer a more transparent board of directors and less corruption scandals but maybe that’s why the share price is what it is.

What do you think?  Do you own a HYP?  If yes, is it delivering what you hoped it would?

Always do your own research.