Guy Carson re-examines the yield stocks he presented over a year ago and provides an update on the list.
Australian equity investors are obsessed with dividends and with good reason. Over the last decade, the benchmark return has been dominated by them. A big reason for this is that compared to global peers, our largest companies pay out a significant proportion of their earnings. Unfortunately this means they retain less capital for growth.
The franking credit system is partly responsible with dividends here more valuable to retail investors. Dividend and franking credits are so valuable that is not uncommon to see companies raise equity for capital expenditure and / or acquisitions whilst maintaining their payout (the alternative would be cutting the dividend and retaining capital). When we look at private investors’ portfolios we quite often see concentrated holdings across the big four banks, infrastructure plays such as Transurban and Sydney Airport and of course, Telstra.
Telstra to us is a warning shot for investors that focus purely on yield. We first speculated that Telstra will cut their dividend in February last year (see here), since that time the stock price has traded down from above $5 to below $2.80. With the recent FY19 guidance, holders should be prepared for another significant dividend cut next year as well.
When companies pay out a high proportion of their earnings, quite often their dividends become unsustainable. There is no buffer when economic conditions turn. This was the case with Telstra and we believe will become the case for the banks. The banks on aggregate pay out 70-80% of their earnings which makes them vulnerable. We have written previously about the headwinds banks face (see here) and if the recent slowdown in the residential property market continues, we believe the dividends will be unsustainable.
So where can investors find sustainable yields? Well, around 16 months ago, we wrote an article outlining our favourite yield plays (see here). In that article we explained what metrics we look at in order to determine if a dividend is sustainable. These metrics were:
At the time we identified seven companies that were yielding on a gross basis between 4.3% and 9.5%. The original table is below.
Fast forward 16 months and the returns from this collection of stocks are strong. The average return is 41.5% with a range from 5.8% to 98.1%. All of the stocks have provided a positive return. Note that Melbourne IT is now known as ARQ Group with the stock code ARQ.
This return highlights an important aspect of investing. Whilst dividend yields are nice and a sign of a profitable company, what really matters is total return. Buying purely for yield quite can often be a good way to go backwards. In fact, when examining historical stock performance, the most important aspect of a dividend is the rate it grows rather than the level of the dividend itself.
The stocks above have all advanced since we wrote about them 16 months ago. As a result, the yields on most of them have fallen. Within our portfolio we have added several new names all with significant yields. A selection of these is listed below.
There are some reasons why these stocks are offering significant yields.
Whilst we don’t focus on yield, we do acknowledge the importance of receiving dividends as part of a total portfolio return. Paying consistent and increasing dividends is a one sign of a high quality company. The sustainability of the dividend is of paramount importance to us though. When companies cut their dividend, as was the case with Telstra, the pain can be severe.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.