Show me the money : Why every dividend has its day

With share prices falling, newspapers and magazines are suddenly full of stories about the importance of investing in companies that pay high dividend yields.

Call us old-fashioned, but Alpha has always believed income-generating stocks have a vital role in any sensible long-term portfolio. Finance theory actually calls this the “Bird in the Hand” concept – for obvious reasons.

But investing directly in stocks for yield can be problematic. The historic yield, of course, can be inflated simply because the share price has fallen while the reported dividend has stayed the same. Falling share prices usually means the likelihood of the dividend being maintained is lower.

Another hidden trap is payout ratios. A feature of the recent profit seasons was a number of companies increasing their dividends to sweeten the total shareholder return. But a close look at the results showed higher dividends were often due to higher payout ratios rather than companies having surplus cash to give back to shareholders.

The danger is that by increasing their payout ratios, too many companies will have less money to reinvest for future growth.

Another painful reminder in recent months was that high dividends, even if they can be maintained, are not always a strong support for share prices.

Take the major bank stocks, now 40 per cent below their 52-week highs. They are on average forward PE multiple of around 10 and yielding around 7% (mostly fully franked), but few institutional investors are rushing to buy them.

Straight yield is not as good a measure as it used to be in indentifying the best income opportunities because there are so many wrinkles in how that yield is generated.

It goes to show, that high-net-worth investors seeking yield should invest in a solid portfolio of stocks, where the stocks are selected based on a hard nosed assessment of the company’s economic fundamentals.

To see a full list of the stocks in the Alpha POWER Shares – 'Asian Lions' portfolio, and Lion Capital’s assessment of them, click here.