Wednesday 10 January 2018

In Search Of Utility (Portfolio Buy)

Economists use the term 'utility' to explain behaviour - essentially it relates to the benefit you gain from buying or selling something. People are simply expected to 'maximise their utility' - in other words, do things that make them feel better off.

That basic principle works pretty well - but when it comes to investing, the new discipline of behavioural economics has found that it is all a lot more complicated.

There is another sense to the word 'utility' - a company providing basic services to the public. like water or power. So, I'm hoping that buying a 'utility' will help to increase my internal 'utility', or well-being. (All that for a play on words...)

My  usual approach when I have cash in the DIY Income Investor portfolio - due to sales, top-ups or accumulated income - is to look at the overall balance of the portfolio. Basically I categorise the income-producing holdings as dividend shares and fixed-income securities (such as bonds) - I try to keep these in balance. Within these broad types I hold some securities directly as well as some 'collective' holdings - Exchange Traded Funds, VCTs and REITs. I try to keep these in balance, too.

So the next purchase needed to be of the 'direct holding' type - a dividend share.

My first stop is to review the FTSE350 for dividend yield - in this case, using This Is Money's performance tables. This particular table also gives the P/E ratio, which is a useful - if crude - measure of how expensive a share is plus Net Gearing, which is a measure of how indebted a company is.

A couple of utilities stick out, with high yields and low P/E: Centrica and SSE but both have relatively high Net Gearing.

But that is only the start. Following the links through to the related company data pages gives access to recent news and company announcements - plus the share price graphs. Ideally, I am looking for a security that is out of favour (i.e. with a share price that has fallen) but which is not going down the toilet. I try to look at the business model and anticipate what might happen in the future. It is also useful to look at cash flow in the annual and semi-annual accounts. How secure is the dividend going forward? How robust is the business model?

Finally I try to avoid concentrating too much of the portfolio in any one market sector.

The conclusion was to go for SSE, with a yield of 6.9% and P/E of 8.4. To quote  This Is Money:
"SSE plc (formerly Scottish and Southern Energy plc) is the holding company of the Group. Its subsidiaries are organised into the main businesses of: electricity generation, transmission, distribution and supply; gas storage, distribution and supply; electrical and utility contracting; home services, supplying a wide range of electrical and gas appliances and complementary products; and telecommunications."

The Half Year Report, published in November 2017 does not provide a lot of comfort, apart from the commitment to an increased dividend - earnings and profits are down although this may be at least partially due to structural changes in the company.

"The Board of SSE  is and will remain committed to remunerating shareholders' investment through the payment of dividends.  It is continuing to target an increase in the full-year dividend for 2017/18 of at least RPI inflation, with an annual increase of at least RPI inflation also being targeted for 2018/19. 

Thereafter, SSE's dividend and dividend policy will reflect the quality and nature of its assets and operations, the earnings derived from them and the longer-term financial outlook.  Excluding household energy supply and services in GB, and based on its financial results for the three years to March 2017, around 80% of SSE's operating profit related to economically-regulated networks and government-mandated renewable sources of energy; and much of that is also index-linked.  Following the demerger, therefore, SSE expects that its target for annual increases in the dividend per share will be at least RPI inflation."

"The Board of SSE plc ('SSE') today announces that it has entered into an agreement with innogy SE ("Innogy") in respect of a proposed demerger of SSE's household energy and services business in Great Britain ('SSE Retail') and combination with innogy's subsidiary npower Group plc ('npower') to form a new independent UK incorporated company to be held by SSE shareholders (following the demerger) and with minority participation by innogy ('Combined Retail Company').  

This transaction will create an efficient new independent energy supply and services business in Great Britain and help create a new market model by combining the resources and experience of two established players with the focus and agility of an independent supplier."

Easing out of the retail business looks like a good idea to me. Anyway - as usual - it is a bit of a price-recovery gamble.

[Purchase price: £13.25]

I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

1 comment:

  1. how about national grid, the power behind the power?