Steady stocks for a rocky market

Colin Morton, senior director at BWD Rensburg tells MoneyWeek where he'd put his money now.

Colin Morton, senior director at BWD Rensburg tells MoneyWeek where he'd put his money now.

The 20%-plus returns we saw from the UK equity market last year were more than welcome. However, I don't think we should expect to be seeing them again this year. There are many reasons to be optimistic: global economic recovery is clearly gathering momentum and growth is becoming more broadly balanced, particularly in the US, where business investment has picked up sharply. We will probably see a similar pattern emerge in the UK as the year progresses, with slower growth in consumer and Government spending more than offset by a recovery in investment and net trade. That should mean that growth in the UK remains close to its long-term trend rate.

But there are also major risks in the market. Leaving aside the potential threat from terrorism, the main ones are interest rates and the US dollar. The equity market has taken the turn in the UK interest-rate cycle in its stride and, although a further rate rise in February is on the cards, I don't think we need worry about rates going dramatically higher.

A bigger threat comes from the US, where the twin deficits have sparked a major sell off in the US dollar. This has the potential to destabilise the recovery and will have to be closely watched. Equity valuations in America are also - as ever - expensive, so it will be interesting to see how the market reacts as US short-term rates turn up.

Most commentators appear to be assuming that any gains for the year will be made in the first half before sentiment deteriorates in the face of increasing rates. But life is rarely this simple, and, anyway, the experience of the past few years suggests that trying to forecast annual equity market returns remains a futile endeavour.

So, in general, it makes more sense to focus on individual, quality stocks. I like those that have the potential to provide consistent returns in what, it appears, will remain a relatively difficult operating environment for most companies. I also try to identify catalysts for change, which could drive re-ratings.

Greene King certainly fits into the category of reliability and consistency. The company has been brewing ale and operating pubs for over 200 years and has grown steadily from its base in Suffolk to become a leader in it field in the south of England. To the year ending April 2004, compound earnings and dividend per share will have grown by around 10% over the past five years. At the current price the shares remain on a discount to the UK market and offer a prospective dividend yield of 3.7%.

The UK tobacco sector is also worth considering. I favour Imperial Tobacco and BAT - both offer free-cash-flow yields of around 10%. About half this cash is being returned to shareholders by way of dividends and the remainder is being used to acquire other tobacco assets. With little or no cyclicality in these businesses, they offer the potential for consistent dividend increases over the medium term.

As for identifying catalysts for change', have a look at the UK real estate sector. This is facing radical change as the Government is currently consulting on a proposal to allow property companies, for a one-off payment of capital gains tax, to convert into real estate investment trusts (Reits). The resultant Reit will then be able to pay out a higher proportion of earnings as dividends. One of my preferred plays in this area is Land Securities. The shares currently trade on a 20% discount to net asset value and offer a dividend yield of 3.7%. If the Reit proposals come to fruition, I would expect a dividend payment of over 60p a share, resulting in a yield of in excess of 6%, based on the current price.

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