Hunt for income: Harsh lessons to be learned

It is the barometer that measures the health of a business, because it is the cash that a business feels happy to pass on once all its other obligations have been fulfilled. However, the ability for this to grow over time depends upon the sensible investment of the funds that the company chooses to retain for its own purpose. Shareholders must be able to rely on management to make sensible capital-allocation decisions.

Perhaps the most famous failure of judgement to befall UK investors was the tragic demise of GEC/Marconi, once famed for its almighty cash balance, but eventually bankrupted following a disastrous acquisition spree during the tech bubble.

In more recent times, we have seen the mining industry generate volumes of cash on soaring commodity prices and pay out substantial dividends, only to come crashing to earth, having relied on debt to finance large capital expenditure programmes. Despite the boom, many have yet to return to the dividend fold and thus into income portfolios.

Rude awakening

Many asset classes and investment strategies received a very rude awakening during the recession. There have been some harsh lessons and revisions, and many a historical precedent has been torn apart. The world of equity income has not emerged unscathed.

However, there is one basic lesson that has been reinforced, the one that points to those reliable, cash-generative businesses that are able to weather storms. These are the same businesses that grow steadily, year after year, because they sell products and services that we use, year after year.

They do not require substantial investment to grow, they do not require leverage to generate returns, and their managements are astute and conscientious stewards of their shareholders’ equity.

Carl Stick is manager of the Rathbone Income fund and director of Rathbone Unit Trust Management