Why aren’t investors buying stocks with 9% yields?
The market seems to be fed up with many of the classic high yield stocks on the London market. Once-popular income plays like Centrica (CNA), Imperial Brands (IMB) and Royal Mail (RMG) continue to fall in value despite offering very attractive dividend yields.
There used to be an argument that high yields from large cap companies would create a theoretical floor for the share price. Put simply, a share price could stop falling once the yield becomes really attractive, such as 6% or more, because investors would mop up the stock in the search for income.
The theory is no longer playing out. Imperial Brands, for example, is now yielding 9.5%. Historically this stock would have been attractive to investors on a yield above 6%. The yield has continued to rise as the share price keeps falling. Year-to-date Imperial Brands is down 9.2%. Over the past 12 months the fall is even worse at 22%.
Very high dividend yields tend to be a signal that the market has doubts over earnings forecasts, financial health or dividend estimates. The falling share price is a reflection of these concerns which results in a rising yield.
So are income investors simply looking elsewhere? The aforementioned companies, as well as the likes of BT (BT.A), ITV (ITV), British American Tobacco (BATS) and Saga (SAGA) which are all yielding above 7%, all have various hurdles to clear in terms of managing investment in their business and achieving earnings growth.
Vodafone’s (VOD) shares have been falling for some time on market worries about the sustainability of its dividend given hefty levels of debt and future investment requirements. The decision to cut the dividend on 14 May failed to win over investors with the stock falling once again.
Another reason why certain income stocks are no longer popular is competition from faster-growing companies which now pay dividends, according to Premier Asset Management fund manager Jake Robbins. ‘Investors are capitulating with many traditional income stocks as they can’t stomach the capital losses,’ he remarks.
‘Sectors with questions about future growth are struggling and investors are now able to get income elsewhere from higher-growth stocks. While yields may only be 2% to 3%, some are growing dividends by up to 15% or 20% a year which means your income is inflation-proofed,’ adds the fund manager.
Although Robbins looks globally for ideas, if you apply his theory to the UK market we find six examples of stocks offering both earnings and dividend growth, and their shares have been rising this year (see table).
You would need to do more research on valuation and sustainability of dividends before thinking about buying any of these shares.
We plan to look at the state of FTSE 100 dividend yields in more detail in next week’s Shares.