Beat poor cash returns with key criteria
Australian stocks have historically delivered a total real return of about 7.5 per cent a year. Add in a few percentage points for inflation and the actual (or "nominal") return is about 11per cent a year.
Not so long ago, investors seeking returns of this ilk were laughed at. Hadn't they heard of mining services companies, or China, or investment banks, asked their brokers?
No longer. Interest rates have fallen to the point where term deposits are lucky to yield 5per cent, with no prospect of preserving your purchasing power. And risks still abound.
The upshot is that now everyone wants an acceptable return, without too much risk. But with a market up 26per cent in less than nine months, the question is where.
Benjamin Graham once said: "To achieve satisfactory investment results is easier than most people realise; to achieve superior results is harder than it looks." Compared with current term-deposit rates, returns of 9per cent before tax should be considered satisfactory. And they're within your reach without too much risk.
The table shows two stocks, along with their current dividend yield grossed up for franking credits, the additional growth required to make a total annual return of 9 per cent, and my estimate of the chances of the company achieving a total annual return of 9 per cent and 15per cent.
My estimate of ALE Property Group's likelihood of achieving a 9per cent return is 80per cent, a high probability. In horse-betting terms, its chances of not hitting that figure are four to one. I've handicapped Computershare's odds of not producing a total return of 9per cent at three to two.
So ALE is a safer bet than Computershare to deliver an overall return of 9per cent. ALE sports an attractive 6.7per cent dividend yield and only has to grow by 2.3per cent a year to make a total return of 9 per cent. With an in-built inflation component to its pub leases, that should be a cakewalk.
Two things might prevent it: if inflation averages less than 2.3 per cent or if something goes awry in the mechanics of the business - embezzlement, improper risk controls or inadequate insurance, for example. Both are highly unlikely.
So, this is a high-yielding stock with inflation protection, offering a very high possibility of a satisfactory return.
But if you're after 15per cent-plus returns, the chances of ALE delivering that are small. I'd estimate only one in 30. Computershare, however, has a far higher chance of reaching that figure.
Yes, market conditions could remain subdued for an extended period, management may not find suitable acquisitions to grow in a stagnant market, and the company may not be able to raise prices. But the benefits of Computershare's now-dominant US business are yet to be reflected in its share price. So, Computershare is less likely to hit 9 per cent and more likely to deliver negative returns, but far more likely to deliver a very attractive outcome than ALE.
Stocks such as these should form the bedrock of your portfolio - the part that generates the "satisfactory" 9 per cent to 10 per cent return base over the long term.
With term-deposit rates so low, consider stocks such as these for that portion of your portfolio where you're prepared to make the leap from government-guaranteed deposits to high-quality stocks.
But you must spread the risk across a number of them.
There are a number of other similarly placed stocks that are reasonably priced, stable, pay an attractive dividend and offer reasonable growth prospects.
Markets may be up and truly cheap stocks are in short supply, but with this approach you need not suffer from poor cash returns that will be eaten away by inflation. Satisfactory returns without the need to take large risks are still within reach.
This article contains general investment advice only (under AFSL 282288).
Nathan Bell is research director at Intelligent Investor Share Advisor, shares.intelligentinvestor.com.au.