Firms that keep their profits to invest in the future
Which stocks are resisting the temptation to hand all their cash to investors? James Connington reports
Over the past three decades the amount that companies invest in future growth has sunk dramatically compared with how much they return to shareholders. Many professional investors are concerned that businesses are neglecting investment in order to meet the demands of income-hungry investors.
Globally, the ratio of company investments to dividends and share buy-backs – where a company buys back its own stock to increase its earnings per share – has fallen by more than 70pc in 28 years.
Of the FTSE 100’s 10 highest yielders, eight have dividend cover (the ratio of profits to dividends) of less than 1, according to Stockopedia, a screening service, meaning they cannot afford to pay their dividends from profits alone.
Cutting dividends is unpopular, but in the long run backing a firm that takes the hard decision to hold back cash from shareholders so it can invest can be a profitable one – as long as the investments pay off.
Telegraph Money asked three top fund managers to name some of the companies that are investing their cash wisely at the moment.
Market value £670m; turnover £87m; pre-tax profit £10m; yield 0.5pc GB Group specialises in identity data, which is used to help businesses check the identity of customers and protect themselves from fraud.
Audrey Ryan, manager of the Kames Ethical Equity fund, said: “GB Group brings together data relating to the identities of 4.4 billion individuals, which helps its customers make good decisions about people.
“It has low capital requirements, which helps it generate a lot of cash. As it is exposed to a market that is growing by double-digit percentages each year, its strategy has been to favour investment over returning cash to shareholders,” she added.
In the year to March 2017 the company delivered earnings per share of 11.4p and paid a dividend per share of 2.4p. Its share price has risen by 82pc over one year.
Market value £580m; turnover £76m; pre-tax profit £7.5m; yield nil Accesso is listed on the junior Aim market and is a leader in “virtual queuing” technology. This can be used, for instance, to notify theme park visitors, via a rentable hand-held device, when it’s their turn to go on a ride. Customers include the Six Flags theme park group.
The firm’s products also include online ticketing software and on-site ticketing services. Its shares have risen by 32pc over the past year and by 550pc over five years.
Richard Hallett, manager of Marlborough’s UK Multi-Cap Growth fund, said: “The company is expected to make a profit of £12m in 2017 but doesn’t pay a dividend. It is expanding strongly and the board has made it clear that in the short to medium term it believes the cash is better invested in growth.
“If a business can achieve a strong return on cash invested, it’s an eminently sensible strategy to deploy it in this way.” Market value £2.7bn; turnover £785m; pre-tax profit £98m; yield 1.9pc HomeServe is a FTSE 250 firm that provides home insurance and repairs. Its share price has increased by 39pc over the past year and by 326pc over the past five years.
Mr Hallett said that it paid about £40m in dividends. “This results in a modest yield of around 2pc. It could have been higher, but the firm chose to invest £50m in growing the business,” he said.
“The more customers HomeServe has, the more efficient its business becomes in new markets such as the US. The company has people out repairing boilers, and the more jobs they can do in an area, the less travel is required and the more profitable the business becomes.”
Market value £5.6bn; turnover £4.6bn; pre-tax loss £2.6bn; yield (2017 estimate) 2.2pc Education company Pearson has had a tough two years and its share price has fallen by more than 50pc from its March 2015 peak. This period has included multiple profit warnings. The collapse was due to problems at its US textbook business, caused by falling student numbers and increasing rental of textbooks via Amazon.
Chris Field, manager of the £4.1bn Majedie UK Equity fund, said: “This culminated in the January 2017 decision to cut its dividend in order to prioritise investment in nextgeneration digital course materials. Dividend expectations have gone from 52p to 18p a share, which looks amply covered by earnings.
“Pearson has also raised more than £2bn from selling parts of its business over the past two years as it simplifies and focuses on its core business.”
Crucially, he explained, the firm has “resisted the temptation” to return this cash to shareholders and has instead given priority to investment and strengthening its balance sheet for the future.
A Bengal tiger dives into the water at Six Flags’ Discovery Kingdom theme park in California. Six Flags is a customer of Accesso Technology