Rising yields may tempt nervous investors back into equities

YIELDS on the stockmarket are heading upwards as the official cash rate is expected to be cut below 4 per cent, enticing investors to shift assets from the safety of cash back into equities.

By InvestSMART · 18 Jan 2012

By InvestSMART ·
18 Jan 2012

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YIELDS on the stockmarket are heading upwards as the official cash rate is expected to be cut below 4 per cent, enticing investors to shift assets from the safety of cash back into equities.

The big four banks were expected to return between 7 and 8 per cent this year, fully franked, while Telstra's guaranteed dividend gives it a yield of 8.3 per cent at the current price of $3.36. Some shares were pushing 16 per cent, such as bread maker Goodman Fielder at a 15.5 per cent yield, but this was not all good news, the head of equities at AustralianSuper, Innes McKeand, said.

"If there is nearly 16 per cent in dividend yield available ... that is an exceptionally attractive return," he said. "The market would say - if we believe in that, we will buy the stock - and the price would go up and the yield would come down.

"The fact that it has not done that suggests that maybe the market does not believe the dividend is actually sustainable." Shares in Goodman closed 15 per cent higher at 48? yesterday. The company faces challenges from volatile prices for its raw materials and pricing pressure from the large supermarket chains which sell its products, according to the head of equities at Morningstar, Andrew Doherty.

APN News & Media had a median yield forecast of 12.7 per cent, but was expected to cut dividends due to lower earnings, Mr Doherty said.

A divisional director at Macquarie Private Wealth, Martin Lakos, said defensive stocks usually paid bigger dividends and had lower earnings growth. But market jitters about the debt crisis had dragged prices down, leaving some sound companies with unusually high yields.

These high-yield shares were becoming more attractive, despite the higher risk associated with equities. Although the cash rate was 4.25 per cent, Mr Lakos said he expected it to fall to 3.75 per cent this year.

"Is an 8 per cent yield from a bank or Telstra a big enough return to compensate for the risk in the sharemarket, compared to a 3.75 per cent yield [cash rate]?" Mr Lakos said.

An RBS analyst, Alva DeVoy, noted corporate balance sheets were relatively under-levered, highly liquid, and had high levels of cash and near-cash holdings. "In our view, Ansell, Boart Longyear, Incitec Pivot, News Corporation and WorleyParsons have the potential to announce or increase buyback programs," she said in a note to clients.

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Frequently Asked Questions about this Article…

Why are dividend yields on the sharemarket rising and what does a falling cash rate have to do with it?

Yields on the sharemarket are rising as the official cash rate is expected to be cut below 4 per cent, which makes cash savings less attractive. With the cash rate forecast to fall from about 4.25% to around 3.75% this year, investors may shift assets from low-yielding cash into equities in search of higher dividend yield and income.

What kinds of dividend yields are everyday investors seeing from major Australian companies right now?

Some big names are showing notably high dividend yields: the big four banks were expected to return between 7% and 8% this year (fully franked), Telstra’s guaranteed dividend equated to about an 8.3% yield at the quoted price, and some companies like Goodman Fielder were reporting yields around 15.5%. APN News & Media had a median yield forecast of about 12.7%.

Are very high dividend yields (like 15%+) a safe bet for income investors?

Not necessarily. Extremely high yields can signal risk: as the head of equities at AustralianSuper noted, if the market doesn’t push the price up to reduce an apparently high yield, it may be because investors doubt the dividend is sustainable. High yields can reflect company-specific problems, volatile raw material costs, or pricing pressure that threaten future payouts.

How should I compare bank or Telstra dividend yields with the cash rate when deciding where to put money?

You can compare income: for example, an 8% yield from a bank or Telstra versus an expected cash rate around 3.75% is attractive on the surface. But experts in the article caution you must weigh that extra yield against sharemarket risk — dividend sustainability, company fundamentals and potential share price volatility — before choosing equities over cash.

What risks are associated with defensive, high-yield stocks mentioned in the article?

Defensive stocks often pay bigger dividends but have lower earnings growth. Market jitters, like concerns about the debt crisis, can drag share prices down and inflate yields. Company-specific risks cited include volatile raw material prices and pricing pressure from large supermarket chains (as noted for Goodman Fielder), which could force dividend cuts.

Could companies with strong balance sheets use share buybacks instead of or in addition to dividends?

Yes. An RBS analyst in the article noted many corporate balance sheets were under‑levered, highly liquid and held high cash levels, making buybacks a possibility. The analyst suggested companies such as Ansell, Boart Longyear, Incitec Pivot, News Corporation and WorleyParsons might announce or increase buyback programs.

Why might a company with a high forecast yield still cut its dividend?

High forecast yields can be based on past payouts, but if earnings fall the company may reduce dividends. The article cites APN News & Media, which had a high median yield forecast yet was expected to cut dividends because of lower earnings — showing yield alone doesn’t guarantee future payments.

What practical questions should everyday investors ask themselves when considering high-yield shares?

Ask whether the dividend looks sustainable given the company’s earnings and cash position, whether current yield compensates for sharemarket risk compared with cash rates, and whether industry issues (like input cost volatility or pricing pressure) could force future cuts. The article highlights these points through expert comments and examples like banks, Telstra and Goodman Fielder.