I’m transferring funds from a managed pension into my SIPP. Before the funds arrive, I’m researching to build a watch list of stocks. This new segment of my portfolio will target a dividend growth strategy influenced by well-known successful fund manager Neil Woodford.
A simple, yet effective, approach
Last year, Mr. Woodford said: “In very simple terms, our total return expectation for a stock equals its dividend yield plus the anticipated rate of dividend growth.”
Focusing on the strength of a growing income stream like that can lead to capital appreciation taking care of itself — if the dividend keeps going up, the share price will likely go up too, as long as the shares don’t overvalue the company.
So I’m doing all I can to make sure the firms on my watch list have strong, good quality underlying businesses, reasonable valuations and, above all, the ability to keep pushing their dividends up year after year.
Today, I’m looking at paper and packaging firm Mondi (LSE: MNDI) and utility cost management consultancy Utilitywise (LSE: UTW) to see if they make the cut for my new watch list.
Impressive dividend records
I can’t fault either firm on their dividend-raising records. Since 2010, Mondi’s dividend is up around 136% and Utilitywise has pushed up dividend payments more than 600% since 2012. Looking forward, City analysts following these firms expect Mondi’s dividend payout to rise another 5% or so during 2017 and Utiltywise’s by around 11% to July 2018.
Mondi’s business has generated decent, rising operational cash inflows that lend support to profits, and borrowings seem under control with net debt running around 1.5 times the level of operating profit. Utilitywise’s cash inflows are more patchy, but net debt is insignificant at around at 1% of operating profit.
Mondi’s operating profit margin runs around 15% and the return on capital employed at just over 19%. Meanwhile, Utilitywise has an operating profit margin close to 21.5% and a return on capital employed of 23%.
These are good figures, so it seems that both firms run good-quality, cash-generating and growing businesses.
Valuations
At a share price of 1,649p, Mondi trades on a forward price-to-earnings (P/E) ratio around 13 for 2017 with the payout covered almost 2.5 times by anticipated forward earnings. Meanwhile, at 185p, Utilitywise’s forward P/E ratio runs at just over nine for 2017 and the dividend yield around 3.8% with the payout covered 2.8 times by forward earnings.
Neither of these companies seems to be overvalued and their businesses look steady. However, both businesses have an element of cyclicality to operations and if world economies tank, I’m sure that trading, and the share prices, will go down in each case.
That said, there’s no sign of business faltering at the moment, but because of their inherent cyclicality I think both companies deserve to maintain a moderate valuation. So, I’m not expecting gains from a valuation uprating, just steady trading progress. I’m happy to include these two on my watch list and may buy some of their shares when my new funds arrive.
