A new tax year prompts decision making

Thursday, 5th April 2018 07:38 - by David Harbage

The prospect of sheltering £20,000 from the taxman by using the annual Individual Savings Account (ISA) allowance should never be taken for granted – be you a taxpayer or not, as such monies are then free of income tax or capital gains tax should your circumstances change (and you become a taxpayer) – mindful that a future government might decide that such generosity cannot continue. Any such move is more likely to see the ISA allowance reduced or halted, than accumulated ISA wealth losing its tax haven status.

As a blog providing comment on equity markets, no mention will be made in this article of the relative attractiveness of Cash or Innovative Finance (peer-to-peer loans and crowdfunding services) ISAs – which most commentators will perceive as being lower risk and higher risk respectively, when compared to the Equity (stock exchange listed company share) ISA.

This article is intended to stimulate fresh thinking on equity selection, as it makes a few suggestions for how the ISA allowance could be invested – based on a presumption that an individual is taking a long term view (of say ten years) and this represents their first equity investment (no existing stock market or other non-cash assets, which might persuade for a different perspective on diversification in particular). The following suggestions should not be viewed as personal recommendations and the extent to which an individual might favour one kind of investment over another will be influenced by personal preference, as much as by the perceived risk-reward.

1. The i share FTSE100 exchange traded fund (ETF) tracks the largest one hundred companies listed on the London stock exchange. These tend to be dominated by mega multinational businesses who are often global leaders in their respective industries – evidenced by the largest ten: Royal Dutch Shell, HSBC, BP, British American Tobacco, GlaxoSmithKline, AstraZeneca, Diageo, Vodafone, Glencore and Unilever. This ETF will typically own each constituent of the FTSE100 index in perfect proportion to its size (calculated by market worth or capitalisation). Accordingly if a company does not perform well, it will be demoted and no longer appear in the ETF’s portfolio; however if a business and its equity worth performs well to merit a place in the top 100, those shares will be acquired by this ETF. This is one of the most efficient (reliable replication) and least costly (total expense of 0.07% per annum) way of owning the FTSE100 index, which currently has an annual yield of 4.25%.

2. Henderson Smaller Companies investment trust, actively managed by Neil Hermon for the past 15+ years, invests in smaller and medium sized UK listed companies. The investment objective is to maximise returns, essentially seeking capital appreciation rather than income - the portfolio currently yields just 2.2%, considerably less than the FTSE100 index. Historic returns have been impressive: as at 28 February 2018, the net asset value of the trust has outperformed its benchmark by 5.3%, 10.2%, 19.3% and 39.6% over 6, 12, 36 and 60 months respectively. Investing in smaller companies is inherently higher risk-reward than the larger FTSE100 universe, but over the longer term benefits of being a smaller corporate entity (such as flexibility) have delivered superior performance (the shares have delivered a total return, i.e. capital appreciation and income, of 306.3% over 10 years). The current £712m portfolio possesses 112 companies (largest exposure is Bellway, at 3.2%), the share price stands at a 10% discount to net assets and the trust charges 0.43% per annum (considerably less than most open-ended funds).    

3. The Vanguard FTSE All-World High Dividend Yield ETF currently invests in more than 1,200 company shares from around the world, with a bias to those paying above average dividend income. The top ten holdings account for 12.5% of the fund, while looking across the whole ETF, geographic listing is based: United States 35.6% Europe 24.4%, Asia 11.5%, UK 9.7%, Japan 6.7%, Australasia 4.4%, Canada 4%, other 3.7%. The US exposure compares to an income-ignored global weighting of almost 60%, and this ETF’s focus on income (yielding 3.8%, this is 1.1% more than global equities would normally produce) means that it has minimal exposure to the very highly valued (and thus susceptible to any disappointment in the) growth technology stocks that dominate Wall Street. Higher income yielding stocks indicate more reasonably rated, staple and profitable businesses and the fund’s largest four positions (in healthcare, oil, banking and food manufacturing) account for 5% of the fund, namely Johnson & Johnson, Exxon Mobil, Wells Fargo and Nestle.

4. A focus on ten industry leading individual UK company stocks offering the prospect of paying higher than average dividends – given the most obvious ISA benefit of sheltering higher rate tax payers from additional income tax – via this limited list: British Land, British Telecom, GlaxoSmithKline, Imperial Brands, Legal & General, Lloyds Bank, Persimmon, Rio Tinto, Royal Dutch Shell and Sainsbury. The critical information, applicable to each FTSE100 stock (offering exposure to  different industries), surrounds:

(a)  prospective dividend yield (based on the current share price, but on the dividend pay-out predicted by the broking community for 2019/20),

(b)  prospective dividend cover (the extent to which that future dividend is likely to be covered by those forecast earnings),

(c)   the prospective price-to-earnings multiple (based on the current share price, but on the earnings predicted for 2019/20), together with a note of profit trend, and.

(d)  brokers’ current recommendations (by reference to being positive, neutral or negative)

British Land – based on the company’s March 2020 accounting year, the shares are set to yield 5.0%, the dividend is covered 1.2 times, the forecast PE is 16.7 times, profits will be flat, broker recommendations: 6 Buys, 7 Holds and 1 Sell.

British Telecom – based on March 2020, shares to yield 7.1%, dividend cover is 1.7 times, prospective PE of 8.0x, profits flat, brokers: 12 Buys, 7 Holds, 3 Sells.

GlaxoSmithKline – based on December 2019, stock to yield 5.8%, dividend is covered 1.4 times, PE 12.5x, flat profits due, brokers: 12 Buys, 15 Holds, 1 Sell.

Imperial Brands – based on September 2019: yield 8.4%, dividend covered 1.3 times, PE 16.7x, flat profits, brokers: 9 Buys, 8 Hold recommendations, no Sells.

Legal & General – based on December 2019, shares to yield 6.8%, dividend is covered 1.6 times, forecast PE 9.4x, flat profits, brokers: 9 Buys, 5 Holds, 6 Sells.

Lloyds Bank – based on December 2019 shares to yield 5.9%, dividend covered 1.9 times, prospective PE of 8.8x, expect flat profits, brokers’ current views: 13 Buys, 3 Holds, 4 Sells.

Persimmon – based on December 2019, stock to yield 8.7%, dividend is covered 1.2 times, PE of 9.2x, single digit profit growth, brokers: 4 Buys, 8 Holds, 3 Sells.

Rio Tinto – based on December 2019, shares to yield 5.3%, dividend cover is 1.6 times, PE 11.2x, single digit fall in profit, brokers: 12 Buys, 9 Holds, 3 Sells.

Royal Dutch Shell – based on December 2019: yield 6.0%, dividend covered 1.4 times, PE of 12.2x, double digit profit growth, brokers: 27 Buys, 4 Holds, 3 Sells.

Sainsbury – based on March 2020, stock yields 4.8%, dividend is covered 1.9 times, PE 10.6x, single digit profit growth, brokers: 5 Buys, 12 Holds, 4 Sells.

So, dear reader, the above features four different ways of taking an interest in company shares and, with the notable exception of the Henderson Smaller Companies investment trust, businesses which are distributing a relatively attractive (certainly compared to cash or government bond yields) income. Perhaps owning a piece of each basket, rather than choosing just one, might be beneficial – although such investment should be viewed over a much longer period of time, it will be interesting to assess the performance in a year’s time.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.