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A blip for the RIRP but 2014 prospects look good October 2013

A blip for the RIRP but 2014 prospects look good

As I decide how to invest the remaining six £1,000 units of the £100,000 notionally available to the RIRP when I launched it at the start of 2008, I don’t know whether to laugh or cry at the extent to which I now find myself a victim of both my previous successes and conservative accounting.

The last published table in July showed that the overall growth in dividends over the years had raised my initial return on capital by 50%, more than twice the rate of inflation, from 4% to 6%. But this means that when I make a new or top-up investment, unless I now invest in something which will give me over 6% in the remaining 5 months of the accounting year — which is clearly impossible — my reported return for the year on the funds invested must by definition fall for each new investment I make.

Higher divis, but a falling yield

My two most recent investments in Direct Line and Reckitt Benckiser highlight the problem. Their latest  dividend announcements mean each of them will pay me at least 5% more than had looked likely when I made my first investment. But because my first dividend from them is only the interim, they each only yield around a third of their full annual return in the rest of this accounting year. And since they have now paid their interims, any top-up investment will now yield nothing until next year.

In retrospect I should probably have adopted an annual time apportionment in calculating the return on newly invested capital, but I rejected this at the outset, partly because the maths is a nightmare, but mostly because what is important for investors is dividend flow, not clever accounting.

In previous years this hasn’t mattered because the organic dividend growth from previous investments had more than made up any slack. But this year has been my annus horribilis, with a dividend cut from RSA and total suspension of dividends and a rights issue at FirstGroup forcing me to eject the latter and crystallise some capital losses.

My end-year performance is not helped by two companies which have not raised their dividends this year. In Balfour Beatty I seem to have picked about the only UK construction company not to be confirming the green shoots of economic recovery. There had even been fears the company’s new CEO might have decided to cut the dividend to provide a fresh start, and the fact he hasn’t is interpreted by the market as encouraging. In normal times I can carry a sleeper or two, and though these are not normal times, the  unattractive reinvestment alternatives means BB stays in, but on sufferance for the time being.

I am also starting to think I may have made a nasty mistake with BP. Despite having set aside a compensation fund the size of the combined GDP of a dozen of the United Nations’ smaller members, the Gulf disaster claims keep coming in, and  the US government continues to threaten punitive fines. The progressive restoration of the dividend towards previous levels on which I had predicated my investment has ground to a halt this year, and insult has been  added to injury by the “sterling effect”: the dividend is declared in US cents, and at the dates on which the last two sterling payments have been calculated, the pound has been relatively strong, so slightly reducing our income.

I have considered various measures to try and boost this year’s income to achieve our target of at least matching inflation. But even though I could engineer an inflation-beating rise in the actual income received by investing all the remaining funds in shares still to pay dividends before end-February, my method of accounting means that I would still be showing a fall in the yield on the total capital invested.

So I have decided to put aside the hair shirt, remind myself that my dividends over the 5 years are up by more than twice the rate of inflation, and stick to the fund’s basic investment rules which have more than proved their value so far.

BP: pay more, please

These are to top up thosecompanies where I do not yet hold my minimum 5 units of investment, whose fundamentals have not changed, and whose share price is below my average purchase price to date. I am ruling out BP because unless and until they can prove otherwise by resuming dividend growth, I assume their fundamentals have changed. This leaves only Direct Line and Reckitt Benckiser meeting the criteria to qualify for new money, so they each get another £1,000. Because they have now both paid their interim dividends for this year, the fund’s accounting problems are highlighted in spades because we have to wait until next summer to see any return at all on this new money.

The projected cash income for the year is slightly higher than last year, despite this year’s disasters, but the higher capital employed reduces it as a percentage. The RIRP needs nearly another £400 income to meet this year’s inflation target.

I continue to wrestle with this issue and am hopeful that in the January issue I can present a solution.

My consolation is that next year none of this should  matter, and will just seem a blip. The fortuitous distribution of cash by Vodafone and a full year’s income from Direct Line and Reckitts should more than compensate for this year’s travails. And who knows, we may even get our maiden dividend from Lloyds.

This allows me to view with equanimity the Labour conference  pledge to resurrect the Command Economy by imposing price controls on the energy companies. SSE and United Utilities make up over a tenth of the portfolio, and any rewriting of the acceptance by government of a need for a proper return on capital would indeed undermine the logic for holding such investments. But in investment terms the 2015 election is still far enough away for such posturings to be seen as random noise — at least for the moment.

Douglas Moffitt, October 2013

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