Companies that have earned a place in traditional income funds by paying a high dividend can end up painting themselves into a corner. Diverting cash that might have been handed back to shareholders to shore up the balance sheet or fund investment in growing the business itself often receives harsh punishment.
Scottish American Investment Company eschews the traditional high-yielding names, in the hope of delivering a dividend that grows faster than the rate of inflation — a feat that the FTSE 250 constituent could manage even amid this year’s runaway consumer prices.
The trust shares the same bias towards growth companies as its Baillie Gifford stablemates. Like other funds managed by the Edinburgh-based investment house, Scottish American backs companies that it thinks are capable of generating high capital growth as well as growing the dividend. Global equities account for 86 per cent of the trust’s holdings, topped up with property and fixed income.
Most UK income funds pick stocks based upon the yield offered by the shares vaulting a certain threshold, say 4 or 5 per cent. The usual stalwarts of UK income funds, energy majors like BP and Shell or cigarette companies like British American Tobacco, don’t appear in Scottish American’s portfolio. Instead, the tech companies Microsoft and Apple and the Danish pharmaceutical group Novo Nordisk are among its largest holdings.
For traditional income investors those selections make for a bizarre approach. Each of those three stocks offer dividend yields of less than 1.5 per cent at the current price. But then also consider that all three stocks have each delivered a total return, which includes share price gains, of more than 150 per cent over the past five years.
Scottish American is looking for companies capable of consistent earnings growth that can fund a steadily rising dividend, even in a recession. Compared with the benchmark, the FTSE All World Index, the companies in the portfolio have on average far less debt, an indication not only of an ability to potentially withstand rising finance costs, but also that dividend payments haven’t been made at the expense of weakening the financial security of the company. The bulk of the trust’s holdings fit into two buckets: those it thinks can generate compound earnings growth of roughly 8-10 per cent a year — Procter & Gamble and PepsiCo — and those that could deliver a more rapid increase of 10-15 per cent, including the American lithium producer Albemarle.
As dividends go, Scottish American is as sturdy as they come. The trust, which was founded in 1873, hasn’t cut its cash return to shareholders in more than 80 years. The trade-off? Investors will need to stomach a lower dividend yield, which amounted to 2.6 per cent based upon last year’s 12.675p a share payment.
Over the past five years, the dividend paid by Scottish American has risen at a compound annual rate of 3.2 per cent, beating inflation over the same period but hardly shooting the lights out. But during the first half of this year, dividend payments rose by 8.6 per cent as the rate of inflation accelerated. This year, dividends paid from its equity holdings are on track to increase by around 10 per cent, which would provide a good base to push the dividend higher on an annual basis for the full financial year.
Scottish American’s real appeal is in the total return the shares have generated compared with peers. The shares have outperformed all bar one London-listed equity income trusts over the past decade, delivering a total return of almost 207 per cent. An ongoing charge of 0.62 per cent is also among the lowest within the global equity income sector.
The trust’s investments have generated a higher return than the benchmark over the past one, three and ten-year periods. The net asset value return totals 230 per cent over the latter period, versus 208 per cent by the FTSE All-World index. The share price return has been lower, at 189 per cent over the ten years to the end of September. The share price discount, a rarity save for a brief pandemic-era dip, reflects some reticence towards growth stocks while inflation runs rampant. If the trust can maintain its record of keeping the dividend up with inflation, there is the chance that the shares could regain their premium once more.
ADVICE Buy
WHY Over the long term, the shares could deliver a high compound total return
Frontier Developments
The stratospheric rise of the video game industry globally means Frontier Developments has not needed to look outwards to propel sales at an impressive pace. It’s taken the developer 28 years of trading to make its first acquisition, purchasing the Canadian studio Complex Games, a former partner, for £11.6 million.
The rationale is twofold. One, it adds a sixth team capable of developing its own video games from scratch. Two, it will help expand the lifespan of Warhammer 40,000: Chaos Gate — Daemonhunters, which was developed alongside Complex, by adding more downloadable content for gamers to purchase. The success of new releases, which this year include the F1 Manager game, is crucial. But Frontier supplements sales by adding content, which three years after a game is released accounts for about half the revenue derived from any individual title.
It is a formula that has yielded good results. Revenue has grown at a compound rate of 25 per cent over the past five years. Profit progress is less linear, depending on the proportion of sales Frontier generates from lower-margin licensed content and spending on research and development, including increasing headcount.
Frontier hasn’t avoided missteps either. A disappointing reception for Jurassic World Evolution 2 at the end of last year; shifting the release of one of its titles out to 2024; and the botched expansion of Elite Dangerous: Odyssey caused management to cut revenue guidance for this financial year to £130 million-£160 million, from the £160 million-£180 million previously expected.
Investors are understandably more cautious, pricing the shares at 24 times forward earnings. That might seem toppy but it compares with a multiple of 48 at the start of last year and an average of 37 recorded over the past five years.
During the last great financial crisis in 2008, discounting increased but was compensated for by higher sales volumes, as games were a relatively cheap source of entertainment. Then again, inflation is running at more than twice the rate it was back then, which could mean gamers cut back.
ADVICE Hold
WHY Lower spending is a risk but growth opportunity exists
