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Many Income Stocks Are Overvalued - So Where To For Yield?

Many Income Stocks Are Overvalued - So Where To For Yield?

By Tony Featherstone 20.05.2013


The Reserve Bank’s late interest-rate cut, and the prospect of more cuts in the next 12 months, will compound the challenge for income-seeking investors. An official cash rate of 2-2.5 per cent, from 2.75 per cent, will make life even tougher for those living off cash investments.

Falling interest rates will also maintain demand for blue-chip stocks that have high, fully franked dividends, such as the Commonwealth Bank and Telstra Corporate, which are overvalued after stellar gains in the past 12 months. Finding reasonably priced yield stocks in this market is hard work.

Of course, share investors should never buy stocks for yield alone. What good is a 6 per cent dividend if the stock falls by 20 per cent and investors are forced to crystallise losses? Nor should income stocks be viewed as a surrogate for cash or other fixed-interest products, as seems the case these days.

Moreover, as share prices rise, dividend yields are being compressed. Telstra, for example, has a forecast 5.8 per cent yield and Price Earnings (PE) of 16 for 2013-14, according to consensus analyst forecasts. Three of four analysts have sells on Telstra, and one a hold, Morningstar data shows.

In 2011-12, Telstra yielded an average 8.6 per cent and traded on a 11.3 PE ratio. A similar comparison could be made for Commonwealth Bank and other income stocks, which have become less attractive on valuations grounds after strong share price gains, yet could rise further as interest-rate cuts stimulate demand for yield stocks.

This scenario has made exchange-traded products that specialise in yield more attractive. Simply put, ETPs are listed funds that aim to replicate the price and yield performance of an underlying index, are bought and sold like shares on an exchange, and are much cheaper than unlisted managed funds.

ASX-listed ETPs had a combined market capitalisation of $7.2 billion, in March 2013, up 32.8 per cent on a year earlier, ASX data shows. The number of ETPs has leapt from 73 to 91.

But much of the growth in ETP market capitalisation has come from the rising sharemarket. Net inflows into ETPs in April were $85 million and total market capitalisation growth was $281 million, according to Betashares analysis.

That said, the ETP market should grow much faster in coming years as more investors, especially Self-Managed Super Funds (SMSF), embrace low-cost index products, and as continued growth in the number and variety of ETPs stimulates greater demand from investors and interest from advisers.

BetaShares said most fund inflow into ETPs in April was for Australian equity income and high-dividend ETPs. More investors are using ETPs to enhance yield, improve diversification and reduce overall portfolio costs. These ETPs make sense for conservative income-seekers.

Owning an ETP that replicates exposure to dozens of income stocks, and gives significantly higher diversification, is arguably a better strategy that chasing overvalued income stocks higher. Yield-focused ETPs work well in the core of a portfolio, providing low-cost, index-like returns and income.

There are four yield-focused ETPs to choose: the iShares S&P/ASX High Dividend ETP (IHD), the SPDR MSCI Australia Select High Dividend Yield Fund (SYI), the Vanguard Australia Shares High Yield ETF, and the Russell High Dividend Australian Shares ETF (RDV). The BetaShares Australia Top 20 Yield Maximiser Fund (YMAX) uses option strategies to enhance yield, and is a clever twist on yield ETPs.

Russell’s yield ETP had the highest distribution yield at 5.14 per cent at March 2013, followed by iShares (4.54 per cent), Vanguard (4.51 per cent) and the SPDR yield ETP (4.04 per cent), ASX data shows. Dividends from the Russell ETP were 77 per cent franked, giving at 12-month trailing grossed-up dividend yield of 6.42 per cent, according to Russell.

Grossed-up yields from these ETPs are competitive with many popular blue-chip income stocks. The Commonwealth Bank, for example, has a trailing 4.6 per cent yield, or 6.6 per cent grossed-up dividend yield after accounting for fully franked dividends.

The advantage of yield ETPs is higher diversification. The Russell High Dividend Australian Shares ETP, on which its ETP is based, had 51 holdings at March 2013. Investors concerned about rising valuation risks for income stocks should consider taking a “basket” or index approach via ETPs.

Vanguard offers the cheapest yield ETP at 25 basis points annually, and it had the highest one-year total shareholder return at 28.06 per cent at March 2013. It looks the pick of the yield ETPs.

Always consider the index on which an ETP is based and the methodology behind its construction. Yield ETPs have subtle, important differences, with some holding more mid-cap stocks that pay higher dividends and enhance growth, but potentially lift volatility.

Click on the links below to read other articles from this week's newsletter

1. 6 Stocks For Yield And Growth (GARP): Why not look for income stocks with good growth...

2. 18 Share Tips - 20 May 2013: 18 Share Tips to BUY, SELL & HOLD from...

3. Many Income Stocks Are Overvalued - So Where To For Yield?: They provide low-cost, index-like returns...

4. The Best Way To Protect Your Portfolio From Losses: Be wary of investment options that promise too...

5. Trade Forex On Herd Instinct: Being a contrarian may enable you to reap...

6. The Frankenstein Economy: From the great recession of 2008 has emerged...

7. Professional Trader: How To Take Trading Losses: I began to manage my trading like I was...

8. Top 10 shorted stocks: Each day we feature the top 10 shorted stocks...

9. Stocks on a roll: ASX rolling 52-week highs for the previous...

10. Stocks on the slide: ASX rolling 52-week lows for the previous...

 

Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Feb 14, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.



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WHAT’S ON THIS WEEK

week 31 October 2014
    • 27
    • ARG Argo Investments annual general meeting | 4:26 AM
    • BEN Bendigo and Adelaide Bank annual general meeting | 4:27 AM
    • SPO Spotless annual general meeting | 4:28 AM
    • RBA Panel participation by Reserve Bank of Australia (RBA) head of financial stability, Luci Ellis at the Australian Housing and Urban Research Institute panel roundtable | 6:07 AM
    • 28
    • AOFM AOFM to issue $200 million of February 21, 2022 indexed Treasury bonds | 4:05 AM
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    • Financial Review's Future Forum Financial Review's Future Forum: The Asian Century, featuring Telstra chief financial officer Andrew Penn, Fortescue Metals chief executive Nev Power and former Australian Ambassador to China Geoff Raby | 4:27 AM
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    • ANZ ANZ-Roy Morgan weekly consumer confidence survey | 5:16 AM
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    • 29
    • MMS McMillan Shakespeare Group annual general meeting | 2:18 AM
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    • SUN Suncorp chief executive Patrick Snowball speaking at American Chamber of Commerce in Australia lunch | 6:09 AM
    • GXL Greencross annual general meeting | 6:46 AM
    • 30
    • IAG IAG annual general meeting | 2:19 AM
    • NAB NAB full year results | 4:23 AM
    • AAD Ardent Leisure annual general meeting | 4:24 AM
    • PAS PAS Group annual general meeting | 4:25 AM
    • FDC Federation Centres annual general meeting | 4:25 AM
    • FLT Flight Centre annual general meeting | 4:26 AM
    • PPT Perpetual annual general meeting | 5:13 AM
    • NCK Nick Scali annual general meeting | 5:18 AM
    • HIA HIA New home sales for September | 5:19 AM
    • AOFM AOFM to issue $500 million of Treasury notes, maturing on February 27, 2015 | 5:19 AM
    • FNP Freedom Foods annual general meeting | 5:19 AM
    • TOL Toll Group investor day | 5:35 AM
    • UGL UGL annual general meeting | 5:42 AM
    • ABS Australian Bureau of Statistics (ABS) international trade price indexes for September quarter | 6:05 AM
    • BTT BT Investment Management full year results | 6:06 AM
    • WES Wesfarmers first quarter sales results | 6:10 AM
    • 31
    • ANZ ANZ full year results | 5:20 AM
    • EGP Echo Entertainment annual general meeting | 5:21 AM
    • ABS ABS producer price indexes for September quarter | 5:22 AM
    • RBA RBA to release financial aggregates for September | 5:22 AM
    • NCM Newcrest Mining annual general meeting | 5:22 AM
    • HIL Hills annual general meeting | 5:23 AM
    • AOFM AOFM to issue $600 million of October 21, 2019 Treasury bonds | 5:23 AM
    • MQG Macquarie Group half year results | 6:09 AM
    • ORG Origin Energy quarterly production report | 6:09 AM

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