Nick Train: the UK stock market has a dividend problem

Star investor Nick Train is the latest fund manager to be interviewed by our collectives editor Kyle Caldwell.

In a wide-ranging interview, Train explains that there’s a tendency for some UK companies to over-prioritise dividends. He says this is one of the reasons why the performance of the UK stock market has disappointed over the past couple of years.

For some holdings in his own portfolios – WS Lindsell Train UK Equity and Finsbury Growth & Income (LSE:FGT) – he has questioned senior executives on dividend policy, which has led to some firms slowing the rate of dividend growth.

Train also names his three simple tenets for stock market success, reveals that he has recently bought a new holding (only the third new holding since 2020), and explains why he is optimistic that better times are ahead for UK equities.

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Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio, I have with me Nick Train, manager of Lindsell Train UK Equity fund and the Finsbury Growth & Income Investment Trust. Nick, thanks for coming in today.

Nick Train, manager of Lindsell Train UK Equity fund and the Finsbury Growth & Income Investment Trust: Kyle, it's a pleasure, or I think it might be a pleasure, I'll tell you in 25 minutes’ time.

Kyle Caldwell: A lot of our viewers will be very familiar with your investment process, but for those who are not, could you summarise it?

Nick Train: To me it's about trying to keep things simple. Trying to, in a sense, behave well. And by that I don't necessarily mean morally well, although I hope that that's also the case. We try very hard not to trade too much. Everybody knows that that's a detractor from value. We try very hard not to diworsify our portfolios, letting them get cluttered by too many ideas. Keep things simple.

And we also try very hard to avoid knowingly investing in speculative or low-quality investments. And what I've found, I have to say not over the last couple of years - let me just put that in there. But what I found is that if you follow those three simple tenets: don't trade too much, keep things concentrated and focused, and keep investing in high-quality businesses; then over time, good things can happen for you.

Kyle Caldwell: So, the fund and investment trust that we're focusing this interview on, invest in the UK stock market. UK equities have been out of favour for several years now, pretty much since the Brexit vote. Why is the UK so unloved and what needs to happen for that to change?

Nick Train: I agree with you. I mean, it's been such a frustrating few years as a career-long UK equity guy, which I am. And, you know, there are so many theories about why the UK has been so disappointing and no one's got any resolutions or answers to it.

I have to say, I think when you look at what's worked globally over the last five years, of course, it's been either big tech digital winners or it's been luxury. Of course, you know, we've seen the French stock market for a brief period of time nudged ahead of the UK in terms of its market cap, because France is the home to LVMH Moet Hennessy Louis Vuitton SE (EURONEXT:MC) and Hermes (EURONEXT:RMS) and others.

And I suppose you have to say if the UK had either a true global tech winner or preferably two or three, an Apple Inc (NASDAQ:AAPL), say, or it had had a heritage luxury stock, maybe people would be feeling more enthusiastic about this market. I think to me, that's the absolute nub of the issue.

I would say, though, that if you look just underneath, let's say the top 10 or 15 biggest companies in the UK, I think there are reasons to be encouraged because there are a number of, in our opinion anyway, true globally significant tech winners in the UK and we're invested in some of them. And also some, if not luxury, certainly premium product, companies also invest in the UK which, well, all of those that I'm alluding to, to us look undervalued, and it may be that global asset allocators are missing a trick if they don't come back and have a look at this market in more depth.

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Kyle Caldwell: The UK market has a rich dividend heritage, but income seekers, now have more choice due to those interest rate rises that have been taking place since the end of 2021. You can now get around  5% on cash and also on certain types of bonds, such as short-dated UK government bonds, known as gilts. So, how would you make the case for UK equities versus those other assets which are considered lower risk?

Nick Train: Well, I would say never invest in equities for income. If you need income, then, as you wisely remarked, there are many other assets that you can turn your attention to. But you invest in equities for, however trite it sounds, long-term protection of the purchasing power of your capital, and if you’re more than a bit lucky, some real growth as well.

I think it’s so important to make this fundamental observation. I hear people saying, should I be investing in gilts? Should I be investing in cash deposits? Listen, the best investment to make is backing honest, smart, hardworking people with a good idea. Do you know what I mean? That what really makes you money. Investing with capable, honest people who’ve got a good idea for a business. And we are, I still think, notwithstanding what we’ve just said about the UK stock market, fortunate that we live today in what is still an open, fair, business-oriented economy.

And I said, it’s a shame we don’t have an Apple, and it is, but a bit of that truly I think is bad luck. You know, there’s enough research going on in our universities. There’s enough people starting up businesses in all fields to make me believe that in 10 years’ time, we’ll look back and say that was just a blip for the UK. This is an entrepreneurial, honest, business-oriented culture and you ought to make money investing in that culture.

Kyle Caldwell: And just following on about your points about income. In a recent note to investors, you made the point that for several of your companies you think the share price would be higher if their respective boards focused on maximising organic growth over dividends. So, could you elaborate a bit more on this? Does this reflect that you think the thirst for income among investors is over-prioritised by some companies?

Nick Train: There's a variety of explanations for why the UK stock market has been disappointing. One of them, I don't think it's the only one, is that you could arguably blame my generation of professional investors. I'm not going to say how old I am, but I was active in the market from the early 1980s onwards and there was a quarter of a century, probably maybe even slightly longer, where investing for income really worked in the UK stock market.

And I was part of that period, unlike a lot of professional investors of my vintage, got into the way of thinking that all you needed to do was invest in a share on a reasonably attractive dividend yield, and tell the board to keep growing the dividend at all costs. Yeah, we got into that habit. I think in hindsight, and the lesson of the United States, the lesson of Nasdaq, is there for us all to see, is that that is a destructive way for companies to run themselves.

Companies, we want them to focus on organic growth opportunities and if that means investing all of the earnings and not paying out any dividends, that's really what we need. And so maybe there has been a cultural issue for the UK. I hope perhaps it's changing a bit, even at an individual stock level - you mentioned what I wrote in the report - we've had really candid conversations with senior executives in some of the companies we are invested in questioning the dividend policy. In some cases, I think I'm pleased to say they've either slowed the rate of dividend growth or in some cases not growing the dividend at all, reinvested more in the business, and we've seen some better outcomes as a result of that.

Kyle Caldwell: So, let's move back to the way that you invest. As you've mentioned, you seldom trade, you buy and hold for the long term, you look for high-quality growth businesses. In terms of your existing holdings, how often are you taking profits, or do you continually run your winners?

Nick Train: Barely ever. You know, I think your terminology is exactly correct. The effect, and I mustn't say it more strongly than this because I don't have a lot to shout about at the moment OK, but we're all trying to do our best according to a set of investment principles and an approach. But absolutely at the heart of what I'm trying to do, [is] trying to identify winners. That's not so easy! Identify winners and then run them, because when you look back over history, and I'm talking decades, it's amazing how well companies and share prices do if you forget about the two or three-year noise, you can suddenly look up 10 years later and think, my God, almost without noticing, this thing has trebled! That's the sort of effect we're trying to capture.

Is there anything wrong with taking your profits and reinvesting? No, there's nothing wrong with it. Is running your winners and not trading the edges of your portfolio always right? No, I can demonstrate it's not always the right way to do it. What I would say, though, is that for us, 1) it works with us kind of psychologically because it's what we want to do, 2) the one thing for sure about the sort of activity you're talking about is that it's costly. You know, there are transaction costs involved in taking profits and reinvesting. And what you're reinvesting has to do as well as what you've sold. And I figured that just at the margin, with no guarantee of superior performance, but just at the margin, doing as little as we do, keep more pennies within the portfolios, keeps more pounds over time within the portfolios. That's all I'd say.

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Kyle Caldwell: The fund and the investment trust [have] around 20 holdings. Do you have a universe of stocks that you think, I've got 35-40 stocks that I could select if the price is right, for example, or do you not think about it in that way?

Nick Train: We absolutely do think about it in that way. And you're right, there are roughly 20 holdings currently. There's easily another 15 that we could access. Going back to how we do it, the other thing I think that’s important is to be fully invested all the time. So, when people entrust their savings to our equity strategy, I don't want to hold cash for them. I'm assuming they've sorted their cash, and their income requirements out somewhere else. They've come to us, the equity market, to own equities. So, I'm fully invested all the time.

I maybe have 15 other interesting ideas, but I've got to be sure they're more interesting than what I currently own, because if they're not, then I'm just shuffling deckchairs on the Titanic. No, I don't mean that, I'm just shuffling assets around and costing my investors money. I do think there's such an emphasis in this business on what's your next idea, what's the novelty that you can show me? Have you done something for me over the last quarter? And, you know,  the grass isn't always greener. Sometimes it is best to stick with what you already own. Anyway, that's our mindset.

Kyle Caldwell: So, that leads on to my next question. When was the last time you had a new idea?

Nick Train: An actionable new idea, do you mean?

Kyle Caldwell: Or a new idea that could be on the substitutes’ bench that you could one day invest in?

Nick Train: Well, I'm going to be coy and a bit of a tease. We're currently actioning a new idea for the UK strategy. We initiated it about three weeks ago (interview took place in mid-October). It's a company that we first seriously looked at about eight years ago. We've monitored it ever since. Maybe it would have been better if we bought it eight years ago, but it definitely wouldn't have been better if we bought it five years ago. It's done nothing for about five years. The stars aligned and this seemed like an interesting time for us to initiate a new holding. That's the third new position in this UK strategy since 2020. To me, that feels quite active. But I guess for most professional investors it would seem like lackadaisical inactivity. So, I guess that's one new idea every year, something like that on average.

Kyle Caldwell: Nick, thank you for your time today.

Nick Train: Well, Kyle, and yours, thank you and your viewers.

Kyle Caldwell: That's it for this episode. You can check out the rest of ourInsider Interview series on our YouTube channel. You can like, comments and subscribe, and I'll hopefully see you again.