The first step before valuing or analyzing the fundamentals of any stock is to monitor the key macroeconomic trends for at least the following economic indicators: Key interest rate, Inflation Rate, and GDP Growth Rate. With these three indicators you get a glimpse at current economic conditions, if there is economic expansion or not, the level of inflation and the key interest rate to form rational investing expectations related to the risk and return in the stock market. The following information applies to the prevailing economic conditions in Australia:
- Reserve Bank of Australia holding the cash rate unchanged at a record low of 1.5 percent
- Consumer price inflation being up about 2.1 percent in a year to June quarter 2018.
- Economy growing at 3.1 percent annually as at first quarter of 2018 (post a 2.4 percent expansion in prior quarter). This has been fastest annual growth rate since Q2 2016.
In this article, we will mention three stocks that trade on the Australian Securities Exchange (ASX) which all have one common feature, a high dividend yield, classifying them in the category of income investing. The three stocks are:
- G8 EDUCATION LIMITED (Ticker: GEM), Industry Group: Consumer Services
- FORTESCUE METALS GROUP LTD (Ticker: FMG), Industry Group: Materials
- NATIONAL AUSTRALIA BANK LIMITED (Ticker: NAB), Industry Group: Banks
However, whether these dividend yields are really worth investing in the stocks is what is needed to be understood. There are many reasons why high-dividend stocks fall under a special investing strategy, and the most important ones are they can substantially increase investing profits during a holding period, they can be analyzed separately through fundamental analysis focusing on the dividend growth, they can reduce overall portfolio risk and its volatility, they have the potential to offer tax advantages, and lastly they can preserve purchasing power of capital at a large degree. From the above macroeconomic data, a high dividend at the current low level of key interest rate and at relatively low inflation rate provides an attractive real return adjusted for the risk and the inflation rate.
Here is some key economic data for the above three stocks discussed here:
There are many aspects to evaluate about investing in high-dividend stocks, such as earnings, fundamentals, risks, relative valuation and momentum. We will focus on this article on two important criteria, relative valuation and how sustainable are the current and future dividends. Because the worst-case scenario for a high-dividend stock is for the company to cut its dividend, while it is preferable to be stable and increasing to compensate for growth, risk and inflation.
Trading Details –
We will analyze some financial ratios for their values and trend for the past 5-years to examine the safety, growth and sustainability of dividends, the free cash flow per share, the financial strength of the balance sheet and the profitability of the companies.
Dividend History (in AUD) –
A look at the free cash flow component is very important since dividends are paid for with cash rather than earnings and the profitability of the companies. The reasons are simple yet very crucial. A positive and growing free cash flow per share, a conservative dividend payout ratio, a strong balance sheet with moderate to low levels of debt and increased profitability over time are some of the most important key metrics to perform a financial analysis of these stocks. If we look at the key financial ratios and the 5-year trend for the 3 stocks, the pay out ratio for GEM has reduced in year 2018 from otherwise high levels of year 2015. This has been owing to the issues seen for performance of the stock given occupancy related challenges. Payout ratio for FMG saw some surge in early 2018 while NAB has maintained the ratio in and around 85% to 90%. All three stocks have had a reduction in net profit margin. NAB has seen some headwinds owing to Royal Commission and other banking sector stocks outperforming NAB while FMG has been impacted by commodity price scenario. Group’s FY18 revenue was significantly down by 18% compared to FY17 as the average iron ore price received reduced to US$44/dmt from FY17 levels of US$53/wmt.
Given the scenario, GEM has been on an unreasonably high payout ratio and paying more in dividends than being earned raises some alarm while looking at payout ratio of the sector as a benchmark. While NAB and FMG may look interesting from dividend scenario but recent results have casted some doubts on future performance.
In terms of relative valuation, the stocks may look a bit undervalued with price to earnings ratio and book value being low when compared to industry scenario. Thus, there seems to be an opportunity to watch out the performance going forward as in an event that their shares appreciate in the future, the high dividend yield can contribute to the overall holding period return.
The Income available from dividends remains attractive for many investors.
We take a look at the best yields on the market and assess what they say about a company’s prospect.
One Thing is certain, though, Australia interest rates are still low, making income difficult to come by and keeping the focus for many investors on high yielding stocks. Kalkine’s team of analysts bought you handpicked report for “Top 25 Dividend Stocks For 2018.”
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