stocks solely on expectation of consistently high yields.”
While stocks paying more in dividends than earnings
risk falling into yield-trap territory, so too do those that
“smooth out” underlying earnings weakness with a
higher payout ratio, says Donohue. When searching for
stocks with payout ratios justifiably higher than the 75%
average, he suggests looking for industries not requiring
much capital to sustain the business or dividend, and
cites health insurers as one example.
Sean Sequeira, CIO with Alleron Investment Man-
agement, says that underscoring the likelihood of future
strong dividends across the market was the quality of
last reporting season, with around half of companies
announcing higher profits, while a similar percentage
lifted their cash holdings. “Stocks with stronger balance
sheets and sustainable cash flows are more likely to
ride out short-term issues, without compromising
their dividends.”
Given that the big four banks are under pressure to
hold dividends at current levels, Sequeira urges investors
to seriously question how much they’re prepared to pay
to own them. With the big four potentially moving into
yield-trap territory, he says dividends from infrastructure
stocks with highly sustainable core earnings may look
increasingly more attractive, even if they’re relatively
overpriced and lack franking credits.Where to find extra income
To help you pick strong, high-yielding businesses to
supplement your income, Money searched for key
stocks from the top 150 companies (ex-bank stocks)
that should, based on certain criteria, be high on the
radar (see table on the next page). The top 10 divi-
dend earners come from a cross-section of sectors
and have an average forecast yield of 8.42%.
Based on the criteria we used, bauxite miner and
alumina refiner Alumina surfaced as the ASX’s top
dividend stock after delivering a final payout of a
fully franked 19.6¢ per share. The only other stock
with a double-digit yield was Whitehaven Coal,
with the cashed-up miner splashing $200 million
in (unfranked) dividends following a 15¢ interim
dividend and a 5¢ special dividend.
Given that they’re susceptible to volatile com-
modity prices, Donohue reminds investors that re-
source stocks can quickly become yield traps.A
t face value, the higher the dividend a
stock pays the better it is. After all, it
means more money is paid to you as
a dividend cheque or more shares are
distributed to you by way of a dividend
reinvestment scheme.
But where investors often come unstuck is in assuming
that a dividend of, say, 6% is indicative of a company’s
future earnings (or yield), when it could be eroded by
one-off events, surprise announcements, poor earnings
or due to a falling share price (aka a yield trap).
The recent spate of abnormally high dividends is due
to a flurry of stocks, including Fortescue Metals, Rio
Tinto, South32, Telstra, Wesfarmers, Caltex Australia
and BHP, issuing special dividends or buybacks. Most
of these special dividends can be attributed to federal
Labor’s plans to take a blowtorch to franking credit
refunds (worth around about $5 billion annually).
Thanks largely to special dividends and buybacks,
CommSecexpectstotaldividendspaidto shareholders
forFebruarytoJunethisyeartobearoundabout
$30billion (ex-banks), up by more than 33% on the
February 2018 reporting season. Admittedly, it’s worth
hunting for companies with cash war chests or hefty
franking credits – with which to make future special
dividends – but John Christou, senior investment adviser
at CommSec, warns investors not to get used to them.
An extended season of special dividends, as companies
move imputations off balance sheets, will eventually
unravel. However, given the imponderables surrounding
Labor’s plans to remove franking credit refunds, Denis
Donohue, of Pentalpha Investment Management, says it’s
not a foregone conclusion that companies will hurriedly
move imputations off balance sheets.Dividends stack up regardless
Assuming most companies offload their imputation
credits by June 30, 2020, Christou reminds income
investors that an average ASX dividend of about 4.5%
(even without franking credits, which grosses up to
around 5.7%) is a compelling alternative to sub-3%
term deposits. “We could see some rotation out of
miners, banks, non-bank financials and REITs into
other sectors that, while they lack franking credits,
simply offer good yield,” he says. “There could be
some dividend traps out there, so be careful of buyingThekey
fundamentals
Money magazine
looked at to arrive
at 10 stocks (top
150 excluding
banks) most likely
to support future
dividends at or
above current
levelsinclude:
Marketcap:
$ 1 billion-plus
stocks typically
have strong
defensive
characteristics.^
Forecast return on
equity: Above 6%
to ensure earnings
cover dividend
payments.
Stock covered by: At
least five analysts.
Forecast and historical
dividend: Above
4.5% ASX average.
Analyst
recommendations:
No consensus calls
to sell.
Net/debt to equity:
Less than 60%
ensures balance
sheets aren’t
over-geared.KEY
FUNDAMENTALS