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VALUE INVESTING
Profiting From High Income Investing

By Stephen Bland (TMFPyad)
May 13, 2005

Here are the latest valuations of my two eternity high yield portfolios (HYP).

In this month's Value Investor I'm starting the newsletter's second high yield portfolio. Encouraged by the success of the first one in its very short life to date, I have every confidence in the second. Unlike the HYPs here, I intend trading shares in the Value Investor HYPs occasionally when I spot attractive opportunities for readers. I have already made one switch in the first portfolio, increasing its yield and scoring a small profit too.

Back to the eternity portfolios. Both were started by investing 5,000 into 15 separate companies - a total investment of 75,000 in each case.

HYP1 - start date 13 Nov 2000

Company                                 Original
price (p)
Price
now (p)
Gain/
(loss)
United Utilities (LSE: UU.)   620 650 +4.9%
Gallaher (LSE: GLH) 416 826  +96.8%
Scottish & Newc. (LSE: SCTN) 490 472 -4.7%
Royal & Sun (LSE: RSA) 393 78 -80.2%
Alliance & Leic. (LSE: AL.) 645 852 +30.9%
Britannic (LSE: BRT) 1,020 443 -57.0%
Lloyds TSB (LSE: LLOY) 705 461 -35.3%
Intercon. Hotels (LSE: IHG) 380 625 +64.5%
Mitchells & Butl. (LSE: MAB) 356 304 -16.0%
Boots (LSE: BOOT) 575 594 +2.3%
Land Securities (LSE: LAND) 771 1,363 +77.5%
Assoc. Br. Ports (LSE: ABP) 321 462 +42.5%
Hilton (LSE: HG.) 232 270 +22.8%
Rio Tinto (LSE: RIO) 1,120 1,622 +43.4%
Anglo American (LSE: AAL) 942 1,210 +27.3%
Shell (LSE: SHEL) 572 469 -18.9%
Total invested    75,000    83,818    +11.8%
FTSE 100      6274.8     4893.4     -22.0%

Year ended          Income
     Yield on
original capital
13 Nov 2001 3,451 4.6%
13 Nov 2002 3,474 4.6%
13 Nov 2003 3,197 4.3%
13 Nov 2004 3,205 4.3%

The estimated value including reinvested income is 99,345, an increase of 33.5% on the original investment in 4.42 years. Equating to a compound 6.6% a year, this is ahead of cash.

The portfolio capital is up 11.8% and continues to leave behind the FTSE 100, the latter having fallen 22.0%. The result is that excluding income it is 43% ahead of it on capital alone but with income reinvested the lead is even greater because of the higher income of the portfolio.

HYP2 - start date 2 Apr 2003

Company                                 Original
price (p)
Price
now (p)
Gain/
(loss)
Lloyds TSB (LSE: LLOY) 338 461 +36.4%
Scottish & Newc. (LSE: SCTN) 348 472 +35.6% 
Dixons (LSE: DXNS) 87 144 +65.9%
United Utilities (LSE: UU.) 546 650 +19.0%
Hays (LSE: HAS) 78 127 +63.4%
DX Services (LSE: DXS) * 0 358 n/a 
Legal & General (LSE: LGEN) 75 108 +44.6%
BAT (LSE:BATS) 580 1,030 +77.6%
Bradford & Bingley (LSE: BB.) 297 303 +2.1%
Hanson (LSE: HNS) 320 481 +50.4%
Land Securities 736 1,363 +85.4%
BOC Group (LSE: BOC) 795 997 +25.2%
BAA (LSE: BAA) 465 598 +28.6%
Shell (LSE: SHEL) 394 469 +19.2%
AMVESCAP (LSE: AVZ) 311 301 -3.1%
Anglo American (LSE: AAL) 970 1,210 +24.9%
Total invested     75,000 104,899    +39.9%
FTSE 100      3753.4    4893.4    +30.4%

Year ended          Income
     Yield on
original capital
2 Apr 2004 4,564 6.1%
2 Apr 2005 4,347 5.8%

The estimated value including reinvested income is 116,022, an increase of 54.7% on the original investment in 2.08 years. Equating to a compound 23.3% a year, this is way more than cash.

The portfolio capital is up 39.9%, ahead of the FTSE 100 which is up 30.4%. The result is that excluding income it is 7% ahead of it on capital alone but with income reinvested the lead is even greater because of the higher income of the portfolio.

General Comment

Nothing so far has disturbed my belief that HYPs are a great long term equity strategy, both for income and growth investors. That is why I have devoted a section of Value Investor each month exclusively to the approach.

We haven't reached the long term yet but the above returns to date have beaten cash, inflation and the FTSE 100 by a long way, the latter in both bull and bear periods in the case of HYP1. This suggests that HYPs are not just a fad that works only in certain circumstances but a strategy which should cope over time with everything the market can throw at it. And all with no more risk than shares generally, with almost no costs and with very little involvement required from the investor.

If it all sounds to good to be true, well, for a change it is true, look at the figures they show that the this clich can be wrong. The reason high yield works and isn't arbitraged out as some might expect is that most investors don't have the patience to follow it. It does take a certain personality to stick with it for years, to avoid almost all dabbling and those are traits not in common supply amongst a lot of equity investors.

When comparing HYP income with cash, note that interest suffers a much higher tax liability than dividends. The latter are tax free to basic rate payers and charged at 25% on higher rate payers. The effect is that gross interest would have to be 25% higher than dividend income in order that the net incomes after tax are the same. So for example a dividend yield of 4% gives the same after tax income as gross interest of 5% whichever tax rate is applicable.

To follow my latest high yield selections sign up for a free 30-day trial of the Value Investor newsletter.

Stephen holds shares in Alliance & Leicester, Lloyds TSB, Royal & SunAlliance and United Utilities.