This trust’s inflation-beating dividend growth makes it a worthwhile income purchase

Having increased shareholder payouts in each of the past 49 years, the Scottish American Investment Company has much to offer

Income investors face a continual trade-off between yield and dividend growth. Some stocks offer exceptionally high income returns today that are significantly greater than the FTSE 100’s 3.6pc yield. However, their dividend growth prospects are somewhat lacking. By contrast, other companies are extremely likely to grow dividends at a faster pace than inflation. But they offer disappointing yields at the present time.

Unearthing stocks that offer the best of both, in terms of a high yield and real-terms dividend growth prospects, is extremely challenging. After all, fast-paced dividend growth is nearly always prompted by rising profits that lead to an elevated share price and suppressed yield.

The task becomes even more difficult when the reliability of dividend payouts, in terms of how many times they are covered by profit and the resilience of a company’s business model, are taken into account. After all, a high yield and the potential for rapid dividend growth are rather pointless if shareholder payouts end up being postponed, reduced or even cancelled.

In Questor’s view, income investors may wish to hold a diverse range of stocks that, in combination, fulfil their need for a worthwhile yield today and inflation-beating dividend growth over the long run. One company that fulfils the latter requirement is the Scottish American investment trust. It has a stunning track record of dividend growth, having increased shareholder payouts in each of the past 49 years. Last year, its dividend increased by 9pc. Over the past decade, its shareholder payouts have risen at an annualised rate of 3.5pc. This is 0.8 percentage points higher than the annual rate of inflation.

Since the trust’s central aim is to deliver dividend growth in excess of inflation over the long run, it is unsurprising it has a strong track record in this regard. Indeed, it focuses on companies from across the world that offer the prospect of fast-growing profits and rapid rises in cash flow that increase the likelihood of higher dividends being paid over future years.

As such, its largest portfolio holdings may not be considered typical income stocks by many investors. Its major holdings, for example, include Microsoft, Apple and Pepsico. While they are high-quality companies in this column’s view, their yields are all below 2.5pc. As a result, the trust’s dividend yield stands at a rather lowly 2.6pc.

However, its holdings are businesses that have solid financial positions, sustainable competitive advantages and proven management teams. Their large size and maturity dictates that, over the long run, they are likely to distribute excess cash to shareholders rather than using it to fund growth opportunities. And since they have dominant market positions in attractive industries, their dividends are likely to prove highly reliable over the coming years.

Pleasingly, the company pays little attention to the make-up of its benchmark, the FTSE All-world index. This is good news for investors who are seeking to obtain index outperformance from their actively managed holdings. With the trust having generated a 205pc capital gain over the past decade, it has outperformed its benchmark’s 179pc return over the same period.

While the company trades at a 1pc premium to net asset value at a time when many investment trusts offer substantial discounts, its solid track record of performance suggests it is worthy of its current market value. Gearing of 10pc means that while it could prove to be volatile, the trust is poised to benefit from an improving outlook for the world economy over the coming years. Although the company also invests in property and fixedincome holdings, they account for just 11pc of net assets. Therefore, equities are expected to be the key driver of income growth and capital returns.

Clearly, some income investors may feel that the trust’s relatively meagre dividend yield makes it uninvestable. But with a large proportion of dividend-seeking investors having long time horizons, a generous income stream today can become rather unattractive if it fails to grow at a faster pace than inflation. Indeed, it will gradually become worth less over time and could lead to reduced spending power.

Therefore, in Questor’s view, the Scottish American investment trust holds long-term appeal for income seekers. Its extended track record of real-terms dividend growth and the reliability of its payout mean it is a worthwhile holding within a diversified income portfolio.

Questor says: buy

Ticker: SAIN

Share price at close: 531p

‘Equities are expected to be the key driver of income growth and further capital returns’