Don’t Get Caught Chasing Yield

For those of us who just want to earn a decent return on our cash, it’s getting harder to satisfy our high-yield appetites.

Remember when you could earn more than 10% on government bonds? Yeah, neither do I. However, for almost a decade, from 1980 to mid-1989, the Aussie 10-year bond was trading at such a yield. Take a look at the graph below.

Source: Trading Economics

 

Of course we are nowhere near 10% yields today. Even as the US Federal Reserve plans to raise rates, Aussie bonds likely won’t yield more than 5% within the next few years to come.

But we’ve become accustomed to high yields. It’s why we jump into stocks if bonds and term deposits can’t satisfy our thirst for yield. While it’s riskier than fixed incomes in many situations, accepting yields of around 2.65% is unacceptable.

And so far in 2017, dividend investors should be laughing. According to Janus Henderson, via Bloomberg, global dividends are on the rise:

Worldwide stock dividend payments in the second quarter rose 5.4 percent from a year earlier to $447.5 billion, according a report released Monday by Janus Henderson Group Plc. The financial and technology sectors were among those showing strong growth.

Close behind the financial sector is the consumer discretionary sector. The worst-performing sector was utilities, as shown below.

Source: Janus Henderson Global Dividend Index

 

But not only are global dividends rising, they could continue their trend throughout 2017. Bloomberg continues:

Dividends are forecast to reach a record $1.21 trillion for all of 2017, up 3.9 percent from a year ago. About half of long-term returns from stocks come from dividends, assuming they’re reinvested and add to compounded growth.

Invest in Highest-Yielding Stocks?

However, that doesn’t mean you should invest in the highest-yielding stocks. For example, look at Telstra Corporation Ltd [ASX:TLS]. The stock has dropped more than 27% this year, pushing up the dividend yield to 8.41%.

You might think it’s an amazing deal to get 8.41% on your money. But as investors found out last month, it was a yield that the telco couldn’t sustain. Telstra will use additional cash to strengthen their balance sheet and invest into new projects.

Based on FY18 of 22 cents, Telstra’s dividend yield is more like 6%, rather than 8.41%.

Stocks with high dividend yields are usually high not because dividends are growing, but because the share price is dropping. As you saw with Telstra, the stock declined because it cut its dividends.

What you want to find instead are stable companies growing income and cash flow over time. Of course, you probably don’t want to buy a stock with a dividend yield of 1%. You’re in the market for income. If you can only get a 1% yield on your cash, you might as well invest in bonds.

What you instead want to find is the highest sustainable yield possible. Meaning you’ll need to analyse the business. Is it growing profits and cash? How stable is its dividend policy? You should ask these questions and more before you jump into any high-yielding stocks.

Regards,

Härje Ronngard,

Junior Analyst, Markets & Money

PS: Self-managed super funds are becoming more popular than ever. They allow you to take control of your financial future and end high management fees paid to professional money managers.

But how do you know if a self-managed super fund is right for you? Find out here.

 


Harje Ronngard is a Junior Analyst at Markets and Money. With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation. It’s not good enough to be right on average when it comes to investing. The market is volatile and it only takes one bad day to ruin your portfolio. You don’t want to end up like the six foot man that drowned in the river that was five foot deep on average. It’s why Harje is constantly reminding investors of their downside risk here at Markets and Money. He does so by simply asking just two questions.  What is it worth? And how much does it cost? These two questions alone open up a world of investment opportunities which Harje shares with Markets and Money readers. Right now Harje is focused on managing research and investments over at the Legacy Portfolio. An investment publication designed to significantly grow investor’s wealth over time with deeply undervalued businesses. Harje also contributes his insights in Total Income, headed by income specialist Matt Hibbard. Harje loves cash-rich businesses, so he feels right at home amongst Matt’s high yielding income plays.


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