AIMing for dividends
Nicholas Hyett explains why he thinks dividends are the key to picking smaller companies.
One of Harry Nimmo’s rules of thumb, when running his Standard Life UK Smaller Companies Fund is to look for companies that pay a dividend. We agree, and think it’s even more important when investing in the volatile world of AIM shares.
Smaller companies are inherently higher risk, and the AIM market is less stringently regulated than the main market on which most shares are listed. This has led to some high profile problems with corporate governance in the past and means small company investing requires particular care and attention. Investors should also bear in mind that liquidity is often lower among AIM stocks, making it more difficult to buy and sell shares and resulting in higher bid/ask spreads.
Our research suggests that over the long run, the total return from investing in smaller companies that pay meaningful dividends is significantly better from that achieved by low or non-dividend payers.
Investors who have sought out shares that offer a higher yield have done much better, as the chart below shows. As ever though, this should not be taken as an indication of future performance, and any investment can see investors getting back less than they invested.
Smaller companies – performance of high yield vs low yield stocks
Past performance is not a guide to future returns
Source: Thompson Reuters, Hargreaves Lansdown quantitative analysis, March 1985 – April 2017
There are a number of possible reasons for this trend. Firstly, while dividends are not guaranteed, they are more predictable than capital movements in the market. So a portfolio of dividend payers is likely to have a smoother returns profile than one that earns only capital gains.
Secondly, we believe that a dividend is a good initial indicator a company is profitable and generating cash. That may sound obvious, but a large number of AIM companies never break out of the red and into the black on either measure. A commitment to paying a dividend conveys confidence that the company is in sufficiently good financial health to return some excess cash to shareholders. It’s also an indicator that management are prioritising shareholders' interests.
With around 24% of AIM companies paying a dividend, I highlight two I believe look interesting;
Nichols - full of Vim
When people think of soft drinks they think of American giants Coca-Cola and Pepsi, but the UK has a rich history in the soft drinks industry too. Vimto may not be as stereotypically British as Britvic’s Robinson’s and AG-Barr’s Irn-Bru, but we think that only adds to parent company Nichols’ strengths.
UK sales accounted for 77% of the group’s £117m sales last year. Rapid 7% growth was largely thanks to the acquisition of frozen drinks company Noisy Drinks in January 2016, although Vimto sales sweetened by a market-beating 4.7%.
International sales account for the remaining £26.6m of sales, up 2.7% at constant currency. The group has delivered a steady positive performance here in recent years, with Africa and the Middle East accounting for 83% of international sales. Vimto is a, perhaps improbable, favourite in many Muslim countries during Ramadan, and although the timing of this year’s holy month held back sales in the Middle East, Africa saw sales growth of 19.7%.
An established and powerful brand has helped the group build a margin that even Unilever would be envious of. Combined with steadily increasing sales that’s allowed the group to maintain or grow the dividend every year since 1995, with the shares currently offering a prospective yield of 1.8%.
Recently the drinks industry has been challenged by the increased focus on healthy eating, and particularly reducing the amount of sugar in drinks. That saw the demise of the group’s Panda Pops range in 2011 and recently culminated in the Soft Drinks Industry Levy in the UK.
However, the group has long focused on promoting the health aspects of its products, indeed Vimto itself was initially developed as a health tonic in 1908. We think that leaves it well-placed versus many competitors.
View our Nichols factsheet
CVS Group – profits from pets
Given the low percentage of AIM shares that pay a dividend at all, we believe investors should treat any yield as an initial indicator, although no guarantee, of quality. That includes companies such as CVS where the prospective yield is just 0.3%.
The group is one the UK’s leading providers of veterinary services, with 388 practices in the UK, a 13% share of the UK small animal veterinary market as well as Laboratory, Crematoria and online dispensary businesses.
Acquisitions have been key to growth, and recent years have seen CVS hoover up independent practices around the country, 67 last year. Combined with steady like-for-like growth, that’s fuelled compound annual profit growth of 19.7% since listing in 2007.
As new surgeries are bought, the group brings its wider service offering to new customers, including diagnostics, the crematoria, own-brand drugs and pet accessory lines. CVS is currently exploring adding pet insurance to the stable in combination with a third-party underwriter. The group’s Healthy Pet Club loyalty schemes now has 291,000 members and offers discounted services and products, with the goal of creating loyal customers who are willing to spend significant sums of money – we’re a nation of animal lovers after all.
Despite the increased scale, margins have remained stubbornly flat over recent years, in the mid-teens at the EBITDA level (earnings before interest, tax, depreciation and amortisation). That’s a source of potential concern, since acquiring small independent practices should provide opportunities for cost savings and cross selling.
Nonetheless cash generation has been strong and that has allowed it to keep debt under control despite the acquisitive growth strategy. Following a £30.2m placing in December, net debt stands at around £68m, a little over twice last year’s EBITDA.
Unfortunately, the fact that CVS is a high quality company is no secret, and that is reflected in its price/earnings ratio, which at 29x is considerably higher than many comparable companies.
View our CVS Group factsheet
Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.