THE INVESTMENT COLUMN

Yield-stock attractions grow

The school of investment thought that high-yielding shares provide the best long-term returns received a boost yesterday after takeover speculation pushed Legal & General's shares 22p higher to 535p.

The latest rise means Legal & General has risen 24 per cent since the beginning of the year, making it the most successful stock in a portfolio of high yielders drawn up in this column three months ago.

In order to test the thinking of an American investor, Michael O'Higgins, who has been an advocate of yield stocks for many years, we compiled a portfolio of shares using his strict criteria, and will be tracking its progress throughout the year.

Almost six months into the year, the portfolio is doing well. Up almost 14 per cent overall, it has outperformed the FT-SE 100 index - up 9.7 per cent over the same period - by more than 40 per cent.

Adapted to the UK market, the O'Higgins share selection method only considers shares in the FT-SE 100, to provide safety and avoid the hefty damage to a small portfolio that one complete failure can inflict. Within the top 100 companies, the system takes the 10 highest yielders and selects the five of those with the lowest share prices. It keeps the chosen shares for a year, before performing the selection process again.

High yielders, the theory claims, tend to be out-of-favour companies due for a bounce. Those with lower share prices tend to be smaller companies and therefore in a better position to grow.

It may sound a simplistic way of choosing shares, but historical evidence suggests it works. Over many years, the capital growth of the shares chosen has outperformed the FT-SE index by a sizeable amount. Because the shares are all high yielders the total return is, of course, even higher. The method is doubly attractive because it avoids the need to research hundreds of shares looking for value, and saves the cost of paying someone else to manage a portfolio.

Because the use of share price as a proxy for size seemed a little primitive, we also drew up a portfolio that selected the final five shares on the basis of lowest market capitalisation. The results for the two portfolios are shown in the table.

The second portfolio's overall performance is less impressive, dragged down by the inclusion of Redland, which cut its dividend in March, and Thames Water, shunned by the market because of its refusal to jump on the sweeteners bandwagon. Even so, the portfolio has kept pace with the index.

The outperformance of the first portfolio's shares may not appear world- shattering in isolation, but that small differential compounded over several years makes a dramatic difference to the end-value of an investment fund. Reinvesting gross dividends as part of a PEP is the best approach.

We will revisit the portfolios in the autumn and at the end of the year.

Lloyd ahead

of the game

David Lloyd, the former Davis Cup tennis player, had good reason to look pleased with himself yesterday. The City has become used to his company, David Lloyd Leisure, serving up good sets of results and the latest figures were no exception.

Pre-tax profits rose 18 per cent to pounds 3.5m in the six months to March, suggesting the company has hit upon a winning formula - leisure centres based on indoor tennis courts backed up by facilities such as swimming pools, ten-pin bowling, bars and restaurants.

That sounds simple enough, but the Lloyd centres have mastered the knack of introducing other features to keep them ahead of the game. The last year's introductions include nurseries where members can leave their children while they play tennis or have a swim. Saturday Clubs have been introduced for children and a Sega Centre is being developed at the club in Birmingham. One-to-one gym training is an idea picked up from the US that may be introduced here.

The result of all that is a membership renewal rate in the 12 clubs of 84 per cent, well ahead of the industry average. Each centre costs pounds 6m to develop and the group's cashflow means it can afford to add two or three new centres each year from existing funds.

Membership costs pounds 230 to join and an average subscription of pounds 40-50 a month. Using the facilities is then free. Only 55 per cent of revenue comes from membership fees; food and beverage sales account for 20 per cent with the remainder coming from guest fees and gaming machines

The company seems ahead of the competition and has a large market to aim at. David Lloyd points out that the Netherlands has 3,000 indoor tennis courts whereas Britain has only 800.

The group is also becoming more operationally efficient, ironing out problem areas such as manual bookings where members can become frustrated if they can't get through to book their court over the phone. The club in Birmingham is testing a touchtone, computerised booking system that will allow members to make a reservation 24 hours a day. Logging a booking through the unmanned system takes 90 seconds.

Analysts are forecasting full-year profits of about pounds 9m and earnings of 11.5p. That puts the shares, which finished 1p lower at 264p yesterday, on a forward rating of 22. An impressive story, but after a good run since flotation two years ago, a high price to pay for the shares.

High-yielding portfolios

Performance since start of year

By share price By market value

Hanson +2.6% MEPC +7.1%

Sun Alliance +18.9% Thames Water -1.0%

MEPC +7.1% Redland -2.2%

BAT +15.8% Legal & General +24.1%

Legal & General +24.1% Sun Alliance +18.9%

Average +13.7% Average +9.4%

(FT-SE +9.7%) (FT-SE +9.7%)