Why I think this quality 7% dividend yield is worth having

The market likes today’s half-year results report from City of London Investment Group (LSE: CLIG), which is an emerging markets specialist and UK-based institutional asset manager focused on closed-end fund investments.

The shares are perky, up around 3.5% as I write, and why not? There’s a lot to like about the company, with the main attraction being the dividend yield, which runs close to 7%. However, I admit that dividends crossing the 7% threshold make me wary because high percentages can be a sign of operational problems ahead and the potential for a cut in the payout. In the case of CLIG, I think the payment looks sustainable because it’s backed by an enterprise that scores well against quality indicators, such as the return-on-capital figure running near 58% and the operating margin close to 37%.

Robust cash generation

On top of that, the company has a good record of delivering annual rises in operating cash flow, which provides decent support to both earnings and the dividend. Meanwhile, today’s share price around 397p puts the forward-looking price-to-earnings (P/E) rating at just under 12, which isn’t too demanding. But it gets better. Although the market capitalisation is £102m or so, the enterprise value is just 82m, suggesting a decent chunk of net cash on the balance sheet. If you discount that cash, the P/E rating falls further, and I think the firm looks like decent value.

However, today’s report reveals that the funds-under-management figure has been slipping, down almost 8% to £3.6bn compared to both the equivalent period last year and six months ago. The firm’s profit before tax is also down, coming in more than 21% lower than the year before. Chairman Barry Aling put the outcome down to weakness in the emerging and frontier market sectors, “together with a degree of ongoing asset re-balancing by some clients.” But he thinks the reduced figures mask gains the company made in the period attracting new funds to its developed and opportunistic value products, “which now represent 15% of the total asset base.”

Choppy emerging markets

I think investors can be a fickle lot, so it doesn’t surprise me that some have been running for the hills when the economic waters get a bit choppy. Mr Aling explained in the report that both emerging and frontier markets suffered falls of 15% and 16% during the company’s trading year. But I’m encouraged by the directors’ decision about the dividend, which suggests a reasonably optimistic outlook. They held the ordinary dividend at last year’s level and declared a special dividend “equivalent to one-half of the current annual distributions.” The ordinary and special dividends together make up that impressive 7% yield.

Mr Aling said the dividend decision demonstrates the directors’ confidence in the company’s recent “marginal recovery in financial performance” and also reflects the prudential capital structure of the balance sheet. The firm ended 2018 with almost £19m of cash in the bank. I like the look of CLIG and would be happy to add some of the shares to my portfolio today.