Sustainability outshines high dividends
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Malcolm Whitten is a portfolio manager at Tyndall Asset Management.
In the search for yield, it's not about chasing high-dividend-yielding stocks - sustainable yields are far more important.
Ongoing market and economic uncertainty has prompted a flight by investors to domestic, defensive higher-dividend-yielding stocks recently. In times of economic uncertainty, investors prefer the near-term certainty of income over the uncertainty of long-dated capital gains.
Falling interest rates on term deposits may also be enticing investors into higher-yielding stocks. At the end of June, the gap between term deposits and dividend yields had widened to its highest level since October 2009.
The historical grossed-up dividend yield (that is, including franking credits) of the S&P/ASX 200 Index was running at around 7.2 per cent versus 3.8 per cent for term deposits (average rate all terms on an investment of $10,000).
Telecommunications, banks and utilities companies have been major beneficiaries of this trend. Telstra (TLS), for example, rose 43 per cent over the past 12 months, versus a rise of around 1 per cent for the broader market (S&P/ASX 200 Accumulation Index), and the stock is trading on a dividend yield of around 8 per cent.
While chasing high-yielding stocks may seem a relatively "safe" strategy when investing in shares, investors need to be aware that there can be traps. The dividend yield is a function of the stock's dividend and its price - a high dividend yield could just indicate that the stock is cheap, and in some cases, cheap for a reason.
Deteriorating businesses can often have a high dividend yield, which proves to be an illusion. Simply picking the highest-yielding stocks without conducting thorough due diligence can lead to substantial underperformance in respect of total return.
In determining whether a stock is good value or just a trap, investors need to assess the underlying health of the company and the sector it operates in.