How Next shares can pay a 26pc dividend

TRACKING down shares which pay a meaty dividend is the Holy Grail for savers in need of a regular income.

Typically, the way you do it is to look at the price of a stock and then see how much its dividend is paying – from this you can work out the yield. This is a percentage of dividends you get back compared to the share price each year.

But some experts are saying that savers are searching in the wrong place. For example, Arm Holdings is one of the biggest companies in the FTSE 100. Valued at £13bn, it designs computer chips and software.

The shares yield around 0.8pc – not exactly a prime candidate for an income seeker. But here’s the key point: the actual yield you are getting depends on the price you paid for the shares – not what the price is today or what it was a year ago.

If you invested in Arm this week when shares were 938p then, with a total dividend last year of 8.78p, that’s how you get the yield of 0.8pc. But if you had invested ten years ago when shares were just 119p, then your actual yield today is around 7.4pc.

This is because you are earning 8.78p for every 119p you invested in the firm.

And unless you’re selling your shares, today’s price is irrelevant. In that decade not only would your capital have grown more than seven-fold as the share price rocketed, but your dividend would have grown at an average rate of 24.3pc a year.

Russ Mould, investment director at AJ Bell, says: ‘All that matters when you’re investing in companies is a rising dividend.

‘Savers shouldn’t be worrying about which company will be the next to cut their dividend, they should be focusing on the ones that will increase theirs.’

Just 26 companies in the FTSE 100 have managed to increase their dividend every year for the past decade.

On January 1, 2006, those 26 companies – which include Next, Vodafone and Diageo – had an average yield of 2.8pc.

Investors who had stuck with those shares for the following ten years are now earning considerably more.

Based on the share prices back then, Next yields 26pc, Paddy Power 18.3pc and Compass 13.3pc. The average yield among those 26 companies now, based on their share price a decade ago, is a chunky 9pc.

That’s double the average yield for the whole FTSE, which is around 4.5pc. On top of that, the share price of these 26 businesses has grown an average of 265pc in that time. If you had invested £1,000 in Next shares on January 1, 2006, over the next ten years you would have received £792 in dividends after tax and the shares would be worth £4,749.

Trying to fathom which are the next generation of shares that will achieve these stellar returns is difficult.

HOWEVER, there are a number of funds which focus on these companies and have a good track record of increasing their own income payouts.

This year the City of London Investment Trust became the first to raise its dividend for 50 years in a row.

The trust, which invests in big FTSE firms such as Vodafone, National Grid and BP, yields around 4.1pc. According to trade body the Association of Investment Companies, some 19 investment trusts have increased their dividend for 20 consecutive years or more. Bankers Investment Trust and Alliance Trust have both grown theirs for 49 years in a row. They have also returned 56pc and 51pc respectively over the past five years.

Mould likes the Chelverton UK Equity Income Fund, which invests in medium-sized firms including Dairy Crest and construction company Galliford Try. It yields around 3.9pc and has returned 87pc over the past five years.

Another favourite is Evenlode Income, which yields 3.7pc and has returned 73pc over the past five years.

Mould says: ‘The fund is another historically strong performer. It leans more towards large companies with plump yields, but four FTSE100 firms which have a ten-year dividend growth history feature in its list of top investments – Diageo, Sage, Compass and Imperial Brands.’