In recent years investors have faced a difficult proposition when it comes to finding yield. Globally interest rates have fallen towards zero meaning government bonds and term deposits have lost significant appeal to the average investor. As a consequence people have been forced into riskier assets, whether it is property or shares, in order to gain income from their investments.

Thankfully on a global basis, Australian investors have had it better than most. Compared to other markets, the ASX features many companies with a yield substantially above peers. So for investors seeking yield, it has been a relatively happy hunting ground in recent years. The big four banks offer significant yields if credit conditions remain benign (something we challenged in our 2017 outlook) and Telstra has provided a gross yield of 9.5% over the last 12 months, although the 10% fall in the share price over the last 12 months offsets this (again we have questioned the sustainability of Telstra’s dividend).

The problem with investing purely for dividends is that sometimes those dividends can fall or disappear. In this regard hasn’t all been plain sailing for Australian investors with dividend cuts from the likes of IAG, QBE, Woolworths and Origin Energy in recent years. To that extent, we question whether investing purely for dividends it is a prudent strategy. Whilst dividends are an important source of returns for equity investors, unsustainable dividends are a good way of destroying capital.

So how do you take comfort that the dividends of a company are sustainable? There are a number of metrics that make sense to look at:

• The payout ratio. If the company is paying out more in dividends than it is earning, that is unsustainable. If the payout ratio is high, the company is also less likely to withstand a shock.
• The cash conversion of their earnings. It’s one thing to have accounting earnings but these earnings need to be backed by cash otherwise an increase in dividends with lead to an increase in debt. 
• The balance sheet. More highly geared companies will struggle to maintain payout ratios if earnings do not continue to grow.
• Earnings growth. Those companies that can grow their earnings are more likely to be able to  maintain and grow their dividends. 

​So all you need is a company with strong earnings growth backed by cash, a solid balance sheet and a maintainable payout ratio. It’s not much to ask really. However, when we look across the universe of Australian companies we find a number of candidates which tick a number of these boxes but fall outside of where investors might traditionally look for yield. All of these companies have a gross yield of over 4% (either on a projected forward yield or a historic 12 month basis in the case of IMF and UOS). 

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