High yielding shares

October 26, 2011, 3:14 pm by David Koch Yahoo!7

If you can stomach the volatility, high-yielding shares may be the answer for income-hungry investors.

Investors looking for income are being squeezed. Savings rates on offer from banks are on the way down, with typical term savings rates falling by 0.30-0.60 per cent for six and 12 month terms, according to Ratecity.com.au, the comparison website.

The banks are having a field day – they don't have to offer top savings rates anymore because the share market turmoil is frightening people into their term deposit accounts. They're hardly even having to advertise for customers at the moment.

On top of that you have variable savings rates likely to take a hit in coming months as the RBA leans towards a rate cutting bias to help boost the non-mining sectors of the economy. (More from David Koch: Why The RBA Needs To Cut Rates)

Now, it is true that the short-term outlook for the stockmarket is very uncertain, and it is no bad thing to have a lot of your money in cash right now.

But it poses a problem for people who depend on income generated by their savings, such as so many retirees. With rates falling, where do you go to keep your income steady?

The short answer could well lie in the stock market, and it is becoming increasingly difficult to ignore top quality, high-yielding shares as good options for investors with enough nerve to ride out this turbulent market. (More from David Koch: Cash In On The Volatile Market)

While I believe this strategy has some merit, there are plenty of caveats I'd like to add, and pitfalls I want to warn you about before being lured by near-double-digit dividend payments on stock market listed companies.

First, don't be suckered in by the level of dividend payments alone.

Many of the dividend figures you will see are presented on a "past year"basis, which means that's the dividend that they paid out last financial year but may not pay out again this year.

What you want to look for is the "forward dividend yield"which is a forecast about what the company thinks the dividend will be next year, taking into account all the information currently at its hands.

Second, ask yourself or your broker, why is the dividend so high? (More from David Koch: Financial Meltdown)

Some shares pay high yields because there has been a change in the outlook for the company's earnings and in many cases these are best avoided. But others are simply caught up in the general stock market malaise and can represent decent buying opportunities, particularly for dedicated income seekers.

Most of our banks fall into this category – price fluctuations mean that fully-franked dividends are effectively in the double digits, yet these are solid companies, albeit struggling a little to lend as much as they would like to in the current climate.

They were also given a fantastic boost by the government last week, which changed the law and allowed banks to issue "covered bonds"as a way of funding future lending requirements. These coveted assets rank above depositors cash in terms of priority in the event of bankruptcy and give our banks a cheaper and more reliable source of funding. This will help insulate them from the rising borrowing on the international money markets.

Sure, the banks' earnings may be difficult to sustain going forwards if the current borrowing slowdown continues, with housing affordability so poor and business confidence cramping demand for finance. But they have not paid out all of their earnings as dividends in recent years, giving them some wriggle-room to when it comes to meeting future dividend payments. (More from David Koch: Official Inflation Figures Misleading)

One approach I like when assessing high-yielding shares is a screening method used by Russell Investments, which analyses high-yielding shares on a variety of criteria, including how well they have sustained their dividends during the past five years, a consensus of brokers about prospects for dividends over the coming three years, historical dividend growth to try and hunt out those companies that have a record of increasing dividend payments year on year, and sustainability of income: how easy will it be for these firms to maintain their earnings?

After applying this analysis to the top 100 companies on the stock market, it compiled a list of its most favoured stocks. Right now they include the following:

YIELD*

CBA Yield: 9.95%

WESTPAC 9.99%

NAB 9.95%

WESFARMERS 7.93%

WOOLWORTHS 7.42%

*Fully franked.

Now, like I say, I'm a big fan of cash holdings at the moment but there are many people for whom increasing their income is such a priority that security of capital is little more than a bonus. (More from David Koch: The Negative Gearing Dilemma)

In these cases it can make sense to regard your savings more like an income-producing "machine".

If you can view it like that, then it needn't matter so much what happens to the value of that "machine"so long as it keeps on producing enough money to meet your needs.

Of course, preservation of capital is great, and capital growth even better, but higher returns come with higher risk, and if you're prepared to take a bit more of a gamble with your capital, your income can be greatly enhanced. You won't find returns over 7% in any cash account, let alone over 8% or 9%.

If your attitude to risk is appropriate, then it may well be worth considering throwing in a couple of top quality, blue-chip stocks with a good record of dividend growth and reasonable outlook for earnings. As such, the above list of shares may prove useful for a part of your portfolio.

For most other people, right now, cash is king.

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