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Fund Managers’ Favourites: Dividend Stocks

VIDEO: Fund manager Hugh Yarrow discusses his three favourite dividend-paying stocks

Alanna Petroff 28 June, 2012 | 10:13AM
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In the video series, "Fund Managers' Favourites", Morningstar speaks with UK-based fund managers to learn about their top investment picks. In this video, Morningstar journalist Alanna Petroff speaks with Hugh Yarrow from Wise Investment about his top ideas for dividend-paying stocks.

Funds and Securities Mentioned in this Video:
Evenlode Income Fund
Unilever (ULVR)
Halma (HLMA)
Sage Group (SGE)

Previous videos from the “Fund Managers’ Favourites” series:
Fund Managers’ Favourites: Small-Cap Picks
Fund Managers’ Favourites: More Small-Cap Picks
Fund Managers’ Favourites: 3 Extra Small-Cap Picks
Fund Managers’ Favourites: 3 Technology Picks
- Fund Managers’ Favourites: 3 Solid Growth Stocks
- Fund Managers' Favourites: High-Yield Small-Caps

Video Transcript:
Alanna Petroff: Making a quick buck in the market is good for some. But for others, it's all about long-term investing in stable companies that pay a nice dividend. That's what Hugh Yarrow focuses on. He is a fund manager at Wise Investment and he manages the Evenlode Income Fund. He joins me today for “Fund Managers’ Favourites” to talk about his three favorite dividend paying companies. Hugh, thanks for joining me.

Hugh Yarrow: Hi, Alanna.

Petroff: So, let's go over your investment strategy briefly.

Yarrow: Well, my focus is on businesses that own intangible assets; so brands that have trusted reputations. These are generally quite friendly to shareholders and good for long-term dividend growth because they generate a lot of excess cash flow. But because they don’t have much in the way of physical assets, most of that is left over for shareholders. They'll invest a little bit in the growth of the business, generally at a high rate of return and that will drive the dividend growth going forward. So, it's well-suited for long-term dividend growth investing.

Petroff: So, Unilever is the first company. That's actually your largest holding in the fund. Tell me little bit more about that.

Yarrow: Yeah. So, you know Unilever is nearly 10% of the Evenlode Fund and it's just a great collection of brands. The business has its roots in the 1930s. But many of the brands go back for 100 or 150 years. We're talking about Lipton tea and Hellmann's mayonnaise and Dove Soap and Sure deodorant. 75% of Unilever's brands are either number one or two in the markets that they operate in.

And because, Unilever's had this colonial past, it's been in a lot of emerging markets for a very long time and has very well entrenched positions. So, for instance, it's been in India since 1880. It's been in Indonesia since the 1930s. It's been in Brazil since the 1920s. So, more than of it sales are from emerging markets and….

Petroff: Okay. What about their dividend though?

Yarrow: Yeah. So, I find it interesting with Unilever in the current market: you can buy it on a 4% dividend yield. I mean, Unilever have grown their dividend 9% per year for the last decade. Looking at the emerging market growth potential that they have over the next 10 or 20 years, I think that looks like very attractive dividend opportunity.

Petroff: Okay. Now, the second company we should move on to is Halma. If you look at the five year graph, they are up about 76%, which is not bad and they also do focus on dividends as well. Tell me a bit about the company.

Yarrow: Halma is a very well managed business. It’s run unashamedly on a long-term basis. Their planning horizon is 10 years plus. It’s a specialty engineering business. It focuses on particular niche markets. To give you two examples: one is health and safety regulation, they’ve got big positions in gas detection and fire detection equipment. Another example is environmental products: they've got the world's most advanced leak detection equipment for drinking water pipes underground. As you can imagine as water gets more and more of a scarce commodity in demand then that sort of product is seeing very good growth rates.

Dividend growth has been very, very solid over the long-term. They've grown their dividend every year for 33 years. I think they are only one of three companies in the UK market that have been able to do that.

Petroff: That's pretty reliable then.

Yarrow: As you said, the shares are up a fair amount over the last three years or so. But, the interesting point with Halma--despite the fact that they are in the engineering sector--during the economic downturn they've still been able to grow their earnings every year at a very good rate. And actually the share price performance is really just a reflection of the fundamental economics of the business driving the earnings forward over that period.

Petroff: Okay. And what's the dividend, right now? Where does it stand?

Yarrow: So, the current dividend is slightly less than 3%. They've recently increased it by 7%.

Petroff: Okay. And the final company, Sage Group…

Yarrow: Yeah.

Petroff: What do they do exactly?

Yarrow: So, they are another great British business. Started in Newcastle in the early 1980s. They've grown over the years to become the market leader in the provision of enterprise software to small and medium-sized businesses, globally. So, they sell to 6 million customers in 160 countries.

The great thing about Sage is that once you’ve started using a Sage package, you're very unlikely to switch. So, to give you an example, if an accountant in a small business is using Sage accountancy software, it's a good package, so they like it. But they just get used to it because it's familiar. Unless something very bad happened, they wouldn't want to change. So, if you look at Sage's business model, their revenues is about more than two thirds of them are subscription based. And the renewal rates on those subscriptions are very high, so more than 80%.

The other great thing about Sage is that it's an intangible asset business. They don't have much in the way of physical assets. So most of the cash they generate is for shareholders to keep. The dividend has grown at more than 30% a year, over the last decade.

Petroff: More than 30%?!

Yarrow: Yeah. They've just last year put the dividend up by 25% and they've got no debt to speak of on the balance sheet. So, it is a bit of a cash machine.

Petroff: Okay. That sounds good. Now, let's go over the key risks for each of those, because we know you love the companies, but we have to go over a few risk. So, let's start with Unilever.

Yarrow: Yeah. I think with Unilever, the long-term growth theme in emerging markets is a very strong one. But clearly that's not going to develop in a straight line. They do have the advantage that they're very globally diversified. But if you had a big slowdown in a lot of emerging market countries then clearly that would affect the rate at which they could grow their volumes and their revenues in those markets.

Petroff: And Halma?

Yarrow: I think Halma, in a way, probably the biggest risk is with capital allocation. The management team has historically done a very good job of reinvesting cash at a good rate of return. When they bought other businesses, they bought them very sensibly at good valuations. But if there was a change in management team and that approach changed, then that could quite significantly change the investment case for Halma.

Petroff: Okay. And Sage?

Yarrow: With Sage, it's probably technology with Sage. They also have to keep evolving. A good example, at the moment, we've got cloud computing. They've obviously got to develop new products that work well on the Cloud. So, there is a sort of continual evolution that Sage needs to go through to make sure that they're up with the latest technology.

Petroff: Okay. Thanks very much. That was Hugh Yarrow. He is from Wise Investment. And I am Alanna Petroff. Thank you very much for joining us.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Alanna Petroff

Alanna Petroff  is a financial journalist with Morningstar UK.