5 shares on my watchlist at the start of 2020

In this article I’ll look at five shares that I think could be worth investing in this year, especially if the stock market falls from its recent highs. All the shares are well suited to investors who are looking to generate an income from their investments or create a portfolio with a high yield. These five shares all yield at least 4% and while that can be because some face challenges I expect all of the companies – and hopefully, therefore, the share prices – to do well this year.

Water and waste

Like many utilities, Pennon Group is not really a growth stock. It carries debt, has a regulator to deal with which caps its growth potential and has to spend money keeping its infrastructure working. It’s a capital-intensive business in the way that a business like Rightmove or Just Eat isn’t.

That said, for an investor more concerned with income, it’s a decent share to own. The dividend yield is 4% – the average for the FTSE 250 is below 3% – and the FTSE 100 average is also around 4%.

What I like about Pennon, which I think ought to boost it in 2020, is that unlike most of its peers it operates two businesses. South West Water – the bigger part – is well run. The other part of the business is the waste management firm – Viridor. Although water regulation is expected to tighten for the next five years, on the upside to date solid cost control has helped generate some of the best returns in the sector, while service levels have been good enough to earn rewards from Ofwat.

The yield of the business alongside the quality of the management puts the shares on my watchlist but with the full knowledge that this share would likely have limited capital growth but lots of income potential. There may also be a boost from investors turning to defensive shares if the economy falters and the threat of nationalisation under a Jeremy Corbyn government has also disappeared.

Turning against plastic

Packaging companies such as Smith (DS) have been hit by a public backlash against plastic. News of plastic in the oceans and the human food chain along with images of plastic bags killing sea life and clogging up rivers have sparked a debate on whether plastic is good or bad. The share price is well down from an August 2018 five-year high.

The dividend yield of 4.3% is about in line with the FTSE 100 which makes it a reasonable investment for an income-focused investor. The historical dividend cover has tended to be over 2 which is a good indicator of the sustainability of the dividend – put another way a cut doesn’t seem imminent. The dividend has also tended to grow most years, except for a slight blip in 2018.

Smith (DS) is responding to the changing environment. Sustainability is moving up the agenda. In March 2019 the packaging manufacturer disposed of its plastics division and it as formed a global partnership with the Ellen MacArthur Foundation – a leader in pushing for a circular economy shows management is taking the change seriously.

The low P/E combined with the high dividend yield means I’m happy to put Smith (DS) on my watchlist for this year and if the share price falls below around 340p then I’d be very tempted to buy.

Money for drugs

Under the leadership of Emma Walmsley, the pharmaceutical giant GlaxoSmithKline has transformed itself and 2019 was a good year for the share price. The group is arguably well behind its rival AstraZeneca when it comes to a focus on R&D but this is now being changed. In 2018 GSK reached a deal with Novartis to buyout Novartis’ 36.5% stake in the Consumer Healthcare Joint Venture for $13 billion (£9.2 billion).

The same year, it announced plans to spin off its consumer healthcare business in a £10bn joint venture with its US rival, Pfizer.GSK, whose consumer brands include Sensodyne and Panadol, will have a controlling stake in the partnership of 68%, with Pfizer owning the remainder. At the time, Walmsley said the break-up would allow GSK to accelerate its priorities in the drugs and vaccine business. The possibility of a leaner more focused business beyond 2020 is one upside to buying the shares this year.

Another is the company’s financial performance. Back in October, it raised its annual profit forecast for the second time during 2018 as sales of its shingles vaccine beat expectations and older medicines, including HIV treatments, continued to sell well. That meant it expected profit to be roughly flat at constant currency for the year, compared with a previous forecast of a fall of 3% to 5%.

Total group sales of £9.39 billion surpassed expectations and was the drugmaker’s sixth consecutive quarterly sales beat, according to Refinitiv Eikon data.

GSK has 12 drugs at stage III trials – the final stage before registration. A further 22 drugs are at stage II of trialling. AstraZeneca has 27 drugs at stage III and 47 at stage II – accounting for why it’s shares are far more expensive than GSK’s. It also highlights why GSK is now playing catchup.

Although behind its competitor in terms of volume of drugs in its pipeline GSK is becoming more focused on R&D, it has a better dividend yield at 4.5% versus below 3% and it’s cheaper than AstraZeneca.

No acceleration

Insurer Direct Line is one of the three shares from the FTSE 350 dividend shares that I think could do well during 2020 – read here for why. As mentioned in that article, the company – and the wider motor insurance industry – faces challenges. Challenges such as falling car sales, competition and margins being hit by comparison sites and changes to the Ogden rate which determines compensation accident victims should get.

The yield of 9% is the main reason for investing in the shares. At this very high rate, it’s not surprising that the dividend cover is often below one, which isn’t great long-term unless Direct Line can improve its earnings per share and profitability. Shorter-term though investors are getting a lot of income from a company with a cheap share price.

The work being done by management to cut costs and make use of technology could also play a role in making the company more competitive and help protect margins at a time when competition is intense. Although the shares have no acceleration currently there is potential for a much better 2020 for shareholders.

An investment to trust

The final share on my 2020 watchlist is an investment trust. The Dunedin Income Growth Investment Trust trades at a 5% discount to its net asset value (NAV) – I like to see discounts when it comes to investment trusts. When I bought Merchant’s Trust a few years back it traded then at a discount to its NAV as well as paying a yield of around 5% which was part of the attraction.

It’s worth noting however that the trust’s discount does tend to be bigger than it currently is. It tends to fluctuate between 6-10%, so buying the share right now could be the wrong move. Over the course of 2020 though the discount might well move back towards the average.

This share price then has many of the same qualities as that investment. The shares yield around 4% and like with other investment trusts the dividend is paid quarterly.

The trust pays a higher dividend because it focuses mostly on larger, higher-dividend paying companies. For example, top holdings include GlaxoSmithKline, British American Tobacco, Prudential, AstraZeneca and Rio Tinto. The trust has a total of around 49 investments, mostly listed in the UK with financials make up 25% of the allocation followed by health care and consumer goods as the next two biggest categories.

This investment trust meets my criteria of having a generous yield and trading at a discount to its NAV which when the discount grows ought to make it an attractive investment. I expect it to do well this year.

 

UPDATE: 13th Jan 2020 – Pennon shares jumped on reports in the media that US private equity firm KKR made a £4bn bid a year ago to no avail for Viridor, while now Morgan Stanley and Barclays have been appointed to manage the sale. An auction will be launched soon.

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