The hunt for yield will accelerate

Key take-out: Higher-yielding shares are those that are paying a higher dividend compared to their share price, but that's often only half the story.

The heightened prospect of the Reserve Bank cutting the official cash rate later this year from the current 1.5 per cent should be ringing alarm bells for investors with high cash allocations.

If it happens – and most economists now think it will – expect an acceleration in the yield hunt as investors adjust their allocations into equities that present the best opportunities for generating sustainable income streams.

But where should one look for the best equities yield opportunities? As most experienced investors will already know, high yields often equate to high risk.

Yet, good and reliable yields can readily be found among the top stocks on the ASX, albeit investors may need to hunt a little harder to find the best opportunities and avoid traps.

The latest Australian corporate earnings reporting season has been a bonanza for shareholders, with more than $29 billion in dividends to be paid out before June. Aggregated data shows the majority of the ASX 200 stocks chose to pay a dividend from the latest earnings period, and 82 per cent of them either maintained or lifted their payouts.

Of those reporting a dividend, 58 per cent lifted the dividend, 17 per cent cut and 24 per cent left dividends unchanged.

Once again the latest reporting term was a mixed bag, with about half of the top companies announcing higher profits and an increase in their cash holdings. And it’s in those companies where many income investors have been winners, through higher ordinary fully-franked dividends and special dividend payouts.

The hunt for yield, or more precisely better yields, is already on – and there is a clear trend emerging that investors are focusing on blue-chip equities that are delivering solid dividend yields between 6 per cent and 8 per cent as well as the prospect of capital appreciation.

The dividend yield is the ratio between a company’s share price and its dividend payout per share; essentially, it shows as a percentage the amount of cash flow being generated from the total investment holding.

Top three yields in the ASX 200

The long-term average yield from the Australian share market is slightly under 5 per cent. But despite various industry pressures, shareholders of the major banks are still getting considerably better returns than that, with dividend yields ranging from about 6.04 per cent for Commonwealth Bank to 7.93 per cent for NAB. On a pre-tax or gross basis, the bank yields range from 8.68 per cent for CBA through to 11.33 per cent for NAB.

But there’s even better yields available within the ASX 200 stocks. Highest among them is Alumina, which continues to deliver a net dividend yield of 12 per cent. That’s on top of the 16 per cent surge in its share price this year, which has been driven by strong aluminium demand.

Alumina has been a strong, steady yielder for many years, and over the past five years has delivered compound earnings per share growth of more than 300 per cent.

Second in the top yield field is Air New Zealand, which continues to trade with a yield above 9 per cent. However the airline recently reported a drop in interim net profit and has revised its revenue forecasts downwards, reflecting challenging market conditions including higher fuel costs.

Third is troubled financial services group IOOF, which is trading with an 8.3 per cent yield – reflecting the sharp downturn in its share price in recent months after the Australian Prudential Regulation Authority (APRA) announced it would be seeking to disqualify the company’s top executives over breaches of the Superannuation Industry (Supervision) Act.

Beware of yield traps

Higher-yielding shares are those that are paying a higher dividend compared to their share price, but in the cases of Air New Zealand and IOOF above, often the raw dividend yield ratio doesn’t tell the full story.

Another is Bank of Queensland, which like IOOF is currently trading at an 8.3 per cent yield. The bank’s share price has dropped heavily over the past six months, reflecting tougher trading conditions and the fallout from the banking Royal Commission – which has similarly hit other financial stocks. The share price fall has inflated the bank’s yield.

There are numerous examples of companies with dividend yields upwards of 40 per cent, but their stories reflect a sharp fall in their share prices coupled with an unadjusted dividend rate. In reality, it is more than likely these companies will cut, or totally stop, their dividend payouts. Some will battle for financial survival.

Companies that collapsed during the global financial crisis, such as ABC Learning and Allco, seemed to be paying great dividends for a while, but they had no value once the companies collapsed.

The lesson here is that investors hunting for yield through equities do need to do their homework, especially when using dividend yields as the key measure.

Another option, of course, is to leave the yield hunt to the investment experts. InvestSMART has a range of income-focused managed funds.

• The InvestSMART Interest Income Portfolio is designed for investors seeking a high level of stability and regular income by investing in domestic and global fixed securities.
  The Portfolio is invested in a blend of 5- 20 Exchange Traded Funds (ETFs), to provide investors exposure to the performance fixed interest assets all managed in the one portfolio.
• The InvestSMART Diversified Income Portfolio is designed to offer investors a sustainable income stream by investing across asset classes, actively managed by our investment team. Having a well-diversified portfolio is a well-known strategy to assist in growing your capital while minimising your investment risks.
• The InvestSMART Australian Equity Income Fund (ASX:INIF) is a concentrated portfolio of 10-35 Australian listed stocks. The Fund focuses on large, mature businesses with entrenched competitive advantages, and dominant smaller companies we believe will produce strong cash flows to support dividends in the future. This Fund mirrors the Intelligent Investor Equity Income Portfolio.

You can learn more about all of InvestSMART’s investment products by clicking Invest With Us.