By: Paul Killik
12.04.2017
Two and a half years ago I introduced a new concept which I called the Killik Income Index. We have subsequently renamed it the Killik Income Monitor, which is a more accurate reflection of what it is trying to do. My latest update should reassure anyone looking at the UK market as a source of equity income.
How it works
Our starting point is the FTSE All-Share Index, from which we calculate the annual income produced by the constituent companies of the index. This is done by according a value of £1 to each unit point of the index: at the market close at the turn of the century (31st December 1999) it stood at 3242.06, which gave us a starting value of £3,242.06. The dividend yield at the time was 2.12% giving us a starting income from the index of £68.73 (2.12% of £3,242.06).
In the period of just over 16 years to the 28th February this year, the index had risen only modestly, growing in value by 22% to £3,953.42. This modest performance was in large part due to the overvaluation of the market at the turn of the millennium following the last major bull market for equities which took a long time to unwind. However, our Income Monitor demonstrates the nominal income generated by the index has now risen by a whisker 100% to £137.58. That currently represents an income yield of 3.48% per annum, which is paid as dividends.
Why this matters
The income produced by a portfolio is often overshadowed by capital growth but it is important for two very specific reasons.
The first is that it contributes to the total return from shares, which is a combination of the capital return and the income return. Importantly, this assumes that income is reinvested back into the index as it is paid. The cumulative income return, plus the growth on the monetary value of the income which has been reinvested, amounted to £3,062.78, over the 16 year period in question. This gives rise to a total return of £7,016.20, which is significantly more than double the starting capital of £3,242.06. This clearly demonstrates the power of compound returns and the long term effect that it can have.
The second reason that income matters is it remains a very important valuation metric when considering whether the stock market is looking cheap or expensive. As I noted earlier, anyone currently investing in the All-Share Index will receive 3.48% per annum in income return. I think most income investors would agree that it is difficult to find such a generous return elsewhere, and more particularly from an asset that has doubled the amount of income that it has paid over 16 very difficult years.
A key relationship
When looking at the valuation of the market, it is very important to remember that a decline in the market has an inverse effect on the yield. The yield will rise if the decline in the index is not mirrored by a similar percentage fall in the dividends paid by the constituent companies. Average dividends are infact widely expected to be higher this year than last, but even assuming they are unchanged, a 10% decline in the All-Share Index would imply a rise in the yield to 3.9% and a 20% decline would raise the yield to 4.3%.
In my opinion the yield on the London market therefore provides a significant underpin to the market’s current valuation. We will continue to track the Income Monitor and will report the value quarterly, as the amount of income that the market produces is critical to determining its overall level.
We encourage you to contact your investment manager if you would like to discuss any of this further.
Or, if you are new to Killik & Co you can contact us on [email protected].
Or, if you are new to Killik & Co you can contact us on [email protected].
