The Reserve Bank’s latest interest-rate cut will force more investors to overpay for blue-chip income stocks and succumb to the TINA (There is No Alternative) trade.
What choice do income seekers have when the official cash rate keeps hitting record lows and measly bank interest rates have turned even asset-rich retirees into income paupers?
Who can blame investors for investing in Commonwealth Bank shares rather than its term deposits? The shares are expected to yield 7.7% after franking; a 12-month term CBA deposit will pay 3% after the 55 basis points increase this week.
The extra yield on bank shares is a no-brainer for income investors starved of yield, even though equities are much riskier than cash accounts. In this crazy interest-rate environment, blue-chip income stocks are, dangerously, being viewed as surrogate bonds.
Low interest rates are forcing investors worldwide up the risk curve to find income. Allocating more assets to equities and less to cash than would usually be the case is an example. As is buying the same small group of stocks because the TINA trade rules, for now.
The three main sources of equities yield – Australian Real Estate Investment Trusts (AREITs), banks and infrastructure and utilities – look problematic on several fronts.
After a stunning rally, the AREIT sector is overvalued against its net asset backing. The big-four banks, offering better value, face more headwinds than they have in years. Big infrastructure stocks, such as Sydney Airport and Transurban Group, are too pricey.
Instead of chasing the same small group of defensive blue-chip income stocks, investors should consider mid- and small-cap shares or listed funds that offer reliable yield.
This strategy does not suit conservative investors. Income streams from mid- and small-cap companies can be more volatile and many offer lower income (or none at all) because they reinvest more earnings back into the business to drive growth. The bulk of income portfolios should always be in defensive, blue-chip companies.
But smaller companies can get a bad dividends rap. Established firms that have lower capital requirements are sometimes ideally positioned to pay a steady, fully franked dividend stream. The best ones have decent capital growth prospects, which, when combined with income, boost the total return. That’s ultimately what matters most.
The Reserve Bank’s interest-rate cut inspired me to scour the market for interesting yield ideas among smaller stocks and listed funds. I sought securities that:
- Yield at least 4%
- Have good prospects to maintain or increase their dividend
- Are reasonably valued
- Are good-quality companies or funds
- In some cases, offer attractive yield with enhanced diversification.
Here are 10 ideas for a mid- and small-cap yield portfolio:
1. DuluxGroup
The building materials group seems an unlikely contender for a mid-cap yield list. But DuluxGroup, highly exposed to the renovations market through its paint division, is less cyclical than many realise and it has an excellent position in a growth industry. At $6.61, with an expected yield of 4%, fully franked in 2016-17, in addition to its capital growth prospects, DuluxGroup appeals. Morningstar values it at $7.
Source: Yahoo
2. Hunter Hall Global Value
Listed investment companies (LICs) are an often overlooked source of dividend yield. The well-regarded investor in global equities yielded 5.26% at June 30 and traded at a 7% discount to its pre-tax net tangible assets, ASX data shows. Like other LICs, it offers diversified exposure through a basket of companies in its portfolio.
Source: Yahoo
3. Hotel Property Investments
The owner of pubs, mostly leased to subsidiaries of Coles, and detached bottle shops, is expected to yield about 6% in 2016-17. The small AREIT looks better value than many of its larger peers. A modest pick-up in inflation, likely as commodity prices rise, would help HPI’s rental income from inflation-linked reviews.
Source: Yahoo
4. Data3
Australian technology service stocks have mostly struggled in the past few years because of government and corporate cutbacks in tech projects and heightened competition from overseas rivals. Data3 has gone against the trend, rallying this year as investors warm to its turnaround strategy and upgraded earnings. It has renewed momentum. No long-term debt and a trailing 4.8% fully franked yield are other Data3 attractions.
Source: Yahoo
5. Asia Pacific Data Centre Group
I have identified the NEXTDC spin-off and owner of data centres as a preferred small AREIT a several times for the Switzer Super Report over the past 12 months. It is a lower-risk play on the cloud-computing boom, has reducing tenancy risks as NEXTDC expands, and offers an attractive 5.4% yield in this market. It’s not cheap, but the distributions look reliable.
Source: Yahoo
6. Platinum Asset Management
The prominent investor in international equities has lagged its high-profile peers with a negative 9% total return (including dividends) over 12 months. Platinum has had modest fund outflows, but has an excellent long-term record and looks undervalued. Platinum’s forecast 6% fully franked yield is attractive, particularly given its low capital requirements and ability to pay more earnings out as dividends.
Source: Yahoo
7. Ainsworth Game Technology
The pokie-machines manufacturer has slumped from a 52-week high of $3.29 to $2.14 as investors fret about the sale of its founder’s shares and challenging conditions in its Australian operations. Ainsworth has excellent long-term growth prospects offshore and after recent share-price falls is expected to yield above 5% fully franked in 2016-17, based on consensus estimates.
Source: Yahoo
8. Contango Microcap
This listed investment company always seems to trade at a discount to NTA, possibly because of the lower liquidity of its underlying asset class (microcap shares). The trailing dividend yield was 6.3% at June 30 and it traded at a 15% discount to its NTA, ASX data shows. The LIC offers diversified exposure to microcaps, always useful, and the discount to NTA should narrow if rising equity markets drive more funds towards microcaps and the small resource sector continues to rally.
Source: Yahoo
9. Vanguard Australian Shares High Yield ETF
The ASX Exchange Traded Funds market has around 20 quoted products that are designed to deliver yield via low-cost index funds. Consider them carefully as different yield methodologies can introduce higher risks. The Vanguard ETF yielded 5.7% at June 30 and had the lowest annual management fee in its category at 25 basis points. It has similar yield to many popular blue-chip stocks, but offers far greater diversification.
Source: Yahoo
10. FlexiGroup
The leasing and finance company has tumbled from a 52-week high of $3.12 to $1.98 after a disappointing trading and strategy update in May. A back-to-basics approach, focus on small-ticket financing and divesture of non-core assets makes sense. FlexiGroup is making tough decisions that could weigh on earnings and dividend growth in the next few years, before the group, a recurring disappointment of late, recovers. The compensation for investors who can ride out a difficult few years ahead is an expected dividend yield above 7%, fully franked, at the current price, albeit with higher risk than others on this list. A Price Earnings multiple of about 7 times has priced in plenty of bad news.
Source: Yahoo
- Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without taking into account your objectives, financial situation or particular needs. Before acting on the information in this article you should consider the appropriateness of the information, with regard to your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at August 3, 2016.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.