Two stocks with safe dividends

A professional investor tells MoneyWeek where he'd put his money now. This week: Michael Lindsell of Lindsell Train Limited, investment adviser to the Close Finsbury Japanese Equity Fund.

In a world where nominal returns on financial assets are low, investors will seek high and safe dividend yields as a measure of value from future investments. Japanese investors value yield more highly than other investors. Not only are yields on bonds and equities in Japan very low compared to those in other major financial markets, but, following years of asset deflation and dividend cuts, the actual safety of the income is more of a concern than elsewhere. This explains why Japanese investors have been persistent net sellers of equities for 15 years. Yet oddly enough, one of our favourite dividend-yield candidates, video-game manufacturer Nintendo, is in Japan.

Nintendo specialises in developing games, a market that, along with electronic arts, it dominates. Success in this field is built around cartoon characters, such as Mario and Pokmon, which inspire loyalty and repeat sales over successive releases. As with other businesses that specialise in creating media content or software, returns on capital invested are high. Over the last ten years, Nintendo has generated sales of £25bn and net profits of £3.6bn. Of that, £0.8bn was paid in dividends, £0.5bn used to buy back shares, and £2.3bn remains in cash on the balance sheet. Although Nintendo's historic dividend yield is only 1.5%, it has the potential to pay more. Not only has the company recently committed to a payout ratio of 50%, which would imply a hike in the dividend yield to 2.5%, but it has also implicitly acknowledged, in repurchasing 8% of its equity over the last three years, that its cash reserves are enough to guard against any unanticipated investment demands or competitive treats. Should the forthcoming release of its new handheld platform, the Nintendo DS, prove a success, it is likely that Nintendo's cash flow and payout ratio will rise further. There is no reason why the payout ratio should not be hiked to near 100%. Alternatively, the company could continue to buy back shares. Nintendo has dividend-paying potential in excess of 5%, and that beats most other global investments.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

A different type of investment is the HBOS 9.25% preference share. At the current price, the dividend yield is 6.5% in perpetuity (it is an irredeemable issue), unless HBOS cut the dividend, which I think unlikely. Before such a cut, HBOS's ordinary dividend (costing currently £1.2bn) would have to be passed, and then the bank would have to judge it necessary to injure its reputation by passing on a dividend costing just £37m. I think we can assume this won't happen, so view the dividend as a fixed-interest investment with an equivalent gross yield of 8.3% (the dividend on a preference share is paid out post-tax, but interest on a corporate bond is paid out pre-tax, so to compare the two you need to gross up the dividend to adjust for tax).

Unlike Nintendo, the dividend on HBOS won't grow. However, the starting yield is so high that, without any capital appreciation, an investment in HBOS preference shares with the income reinvested would double its value in eight years. We also think UK inflation will remain benign, so preference-share prices could rise as fixed-interest yields in the UK decline, so there could be capital gain too. The stock's yield advantage over irredeemable Government bonds seems high, probably 2.5% too high, relative to the security of the dividend stream from such a blue-chip issuer.