How To Build A Portfolio With A 7.4% Yield

Published in Investing on 18 December 2012

If you are prepared to concentrate your investments, a massive yield can be earned.

Super-investor Warren Buffett once said: "Put all your eggs in one basket and then watch that basket very carefully." Buffett knows the value of diversification and the benefits of concentration.

Don't get me wrong, I think diversification is very important. But massive gains can be made by getting just a few picks dead right. Buffett knows this.

I've trawled the market to find a collection of high-yielding shares. The drawback is that my portfolio below contains just a few shares and is heavily biased toward insurance.

CompanyPrice (p)P/E (forecast)Yield (forecast, %)Market cap (£m)
Aviva (LSE: AV)3698.16.810,800
ICAP (LSE: IAP)3099.27.21,960
Resolution (LSE: RSL)25010.98.43,530
RSA (LSE: RSA)12510.97.54,430
Vodafone (LSE: VOD)15810.37.079,160

1) Resolution

Resolution is the big beast of the dividend world. The 800-pound gorilla. Resolution owns Friends Life, a provider of insurance, investments and pensions.

Resolution is forecast to pay 20.9p of dividends for 2012. At today's price, that puts the shares on an 8.4% yield. Normally, cautious investors wince when they see a yield like that. They assume that the payout is a one-off or that it cannot be sustained in the long term.

This will not be the first time that Resolution has ponied up a big dividend. In fact, the payout has been increasing at the company since 2009. Analysts are forecasting that it could even rise further for 2013.

The yield is covered by earnings. That 20.9p would be paid out of 23.7p of expected profits per share.

Markets have recently been cheered by the company's reorganisation of some of its debts. This will save Resolution money, increasing the probability that the large payout can be maintained.

2) RSA

RSA is the company behind the MORE TH>N insurance brand. For a number of years now, RSA has been one of the biggest yields in the FTSE 100 (UKX).

The dividend payout at RSA has been increasing year on year since 2006.

Shares in RSA have risen 13.4% in the last month. This has had the effect of pushing the dividend yield lower. Current forecasts are for earnings of 11.5p in 2012 and a dividend of 9.34p. In 2013, those figures are expected to hit 13.4p and 9.55p respectively.

If more investors believe in those forecasts, then I expect that the RSA share price will move higher.

Of course, any hit to profits could be very bad news indeed. With cover looking so thin, a dividend cut would become more likely.

3) Aviva

Aviva is the third insurance specialist to make my concentrated high-yield portfolio. It is also the company whose dividend investors worry about most.

The Aviva dividend was held at the interim stage. Given that consensus expectations are for a fall this year, clearly some analysts are expecting Aviva's next statement to confirm a cut.

Aviva's management have outlined a series of changes that could lead to £400m in cost savings. If Aviva can remove these costs and maintain profitability, the dividend will be safe.

I worry when companies need to cut costs to maintain profits/dividend. Why is the business no longer as profitable? If a company can manage without rafts of staff/systems, what were they doing there in the first place?

4) ICAP

ICAP is another company planning major cost cuts to improve profitability.

ICAP is an inter-dealer broker. This is a niche within the financial markets. ICAP acts as a middle-man between customers who need to trade securities at a competitive price.

ICAP has made itself the market leader in the field. The company's success saw it grow annual revenues to more than £1.5bn. ICAP was, until recently, a FTSE 100 company.

As activity in ICAP's markets has declined, so have analyst expectations on what the business could achieve. Today, the consensus opinion is that ICAP will deliver earnings per share (EPS) of 33p for 2012. This time last year, expectations were for 41.1p of earnings.

Investors will be hoping that savings in the business and a return to more buoyant trading will secure the dividend for the future.

5) Vodafone

Vodafone has recently announced that it has begun a £1.5bn buyback of its own shares. This is the company's way of spending the payment it recently received from Verizon Wireless, its joint venture with Verizon Communications.

Vodafone has already committed to spending £550m buying back shares between 10 December and 20 February. I had been expecting the entire buyback to push Vodafone's share price higher. After all, £1.5bn is good for almost 2% of the company at today's prices.

Even without a short-term rise, there are still reasons to hold. At the interim stage, the Vodafone dividend was increased by 8.2% to 3.27p per share. If the usual weighting between interim and final dividends is maintained, then Vodafone shares are set to yield 6.2% this year.

So, would Warren Buffett buy these shares? I cannot tell you for sure, but I do know one UK company this billionaire super-investor has been buying shares in recently. To find out which one, get the free Motley Fool report "The One UK Share Warren Buffett Loves". This report will be delivered to your inbox immediately. Just click here to start learning from this master investor today.

> David owns shares in Vodafone but none of the other companies mentioned. The Motley Fool has recommended shares in Vodafone.

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Comments

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giveusaquid 18 Dec 2012 , 12:17pm

"If a company can manage without rafts of staff/systems, what were they doing there in the first place?"

Efficient market hypothesis is one thing, there's probably an equivalent for businesses as well, most have their fair share of people and systems that are unnnecessary, or inefficient, or just not used to their full potential, try all you want you'll never eradicate this.

UrbanDreamer 18 Dec 2012 , 1:06pm

"Put all your eggs in one basket and then watch that basket very carefully."

I think that you may find that Mark Twain used a very similar phrase in a book published in 1894, though he may have borrowed the phrase from Carnegie.

So, did Buffet make it up himself? Is he quoting Pudd'nhead Wilson, the character in the book, or Carnegie?

M0byDick 18 Dec 2012 , 2:22pm

Another from Pudd'nhead Wilson: "October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February." :-)

reinvestmentman 18 Dec 2012 , 9:13pm

I hold AV. RSA and VOD as part of my high yield portfolio,as they offer a nice income stream at the higher end of the yield spectrum, but only as a part of it.I would be most wary about concentrating so intensely in this way .My ideal would be to have positions in these companies alongside holdings in high yield investment trusts.A nice bit of core with the IT's and then a bit of explore with these individual holdings.

ANuvver 18 Dec 2012 , 10:35pm

Well, I happen to hold two of them. But chasing yields this high can be a recipe for horrors.

Simply put, if a yield is exceptionally high, it's often because it's regarded as unsustainable, particularly with such well-watched securities as these. If the main attraction of the share is its comely yield, you have all the downside of a dividend disappointment and little upside.

Except in very unusual situations, I'd tend to be wary of a yield much above 4.5%. No such thing as a free lunch.

I'm all for bucking the trend and investing in productive enterprises at nice prices, but focusing a whole p/f on this kind of stuff could land you with a basket omelette...

goodlifer 18 Dec 2012 , 11:52pm


ANuvver
"I'd tend to be wary of a yield much above 4.5%."

So would I.
And it's not a bad idea to be wary of yields at or below 4.5%.

goodlifer 19 Dec 2012 , 11:18pm

"Focusing a whole p/f on this kind of stuff could land you with a basket omelette..."

So could focusing on any other kind of stuff

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