Buy Hold Sell

10 of the highest-yielding stocks on the ASX

Tue 11 Jun 24, 12:00pm (AEST)
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Source: Plato Investment Management's Peter Gardner, Livewire's Ally Selby and Merlon Capital's Andrew Fraser | Livewire Markets

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Key Points

  • Double-digit dividend yields on the ASX are halved from last year, indicating potential issues such as limited growth prospects, falling share prices, or one-off dividends
  • Stocks with trailing yields of over 10% often signal potential dividend cuts or low growth
  • Insurance stocks, particularly Insurance Australia Group and QBE, are favored for sustainable and growing yields due to favorable macroeconomic conditions and premium growth

There are currently 10 stocks with double-digit yields on the ASX, exactly half the amount there was this time last year.

While double-digit yields certainly sound enticing, investors should be aware that they could indicate that the market believes a company has limited growth prospects, a falling share price, or a one-off dividend.

For those not in the know, dividend yield is calculated by adding up all the dividends (both special and normal) paid over the last 12 months and then dividing that value by a stock's current share price. You can check out the highest-yielding stocks on the ASX below:

Screen Shot 2024-06-07 at 1.57.14 pm
Source: Market Index

So, are any of these double-digit yields sustainable?

To find out, Livewire's Ally Selby was joined by Plato Investment Management's Peter Gardner and Merlon Capital's Andrew Fraser.

They share at what point alarm bells should start ringing on the sustainability of these yields, and where they are seeing growing yields over the short and long term. They also each name a stock they are backing - which surprisingly, are both incredibly similar - for attractive income over the next few years.

Note: This episode was recorded on Wednesday 5 June 2024. You can watch the video, listen to the podcast, or read the edited transcript below.

Other ways to listen:

Edited Transcript

Ally Selby: Hello and welcome to Livewire's Buy Hold Sell. I'm Ally Selby, and today we're taking a look at some of the highest yielding stocks on the ASX - are those yields sustainable? And if not, where should you be looking instead? To find out, we're joined by Pete Gardner from Plato and Andrew Fraser from Merlon. Let's get straight into it. Is there any evidence that demonstrates why investors should be focusing on companies that pay dividends or those that are reinvesting in companies for growth? I'm going to start with you, Andrew.

What does the research say?

Andrew Fraser: There's a lot of studies that show investment strategies that focus just solely on dividend yields don't outperform through time. It's important to remember that dividend is just one component of total return. And ultimately, dividends are only sustainable if the companies generate sustainable free cashflow to cover them, and that's our focus at Merlon.

Ally Selby: Over to you, Pete, I feel like you might be biassed. You're an income investor. Is it important to focus on stocks that pay those kind of growing sustainable dividends or do you sometimes take a look at companies that don't pay dividends that they're investing in their own company for growth?

Peter Gardner: We try and get the best at both worlds and have a portfolio that generates both income and growth. Our studies show that if a stock is not paying any dividend at all, that in general it underperforms, and that's probably because there's some unprofitable businesses in that group that generally do worse. But after saying that, there's not a strong correlation once you start paying a dividend between how high that dividend is and when you underperform. We also find that stocks that cut their dividends generally underperform, especially upon announcing that cut, and so you want those dividends to be sustainable ideally, especially if the market's not predicting that you're going to cut.

When do the alarm bells start ringing?

Ally Selby: There's more than 40 stocks on the ASX with dividend yields higher than 7%, which sounds obviously quite attractive. At what point do the alarm bells start ringing, you think, oh, that dividend yield might not be sustainable?

Peter Gardner: So for an individual stock, what we're looking for is if that stock's payout ratio is getting close to 100% and even particularly when it's over 100%, obviously that means it's not going to be sustainable going forward. When you look at the overall market level, at the moment though, we've got what we call a dividend cut model, which predicts the chance of any stock cutting its dividend in the next results. And what we find is that that dividend cut model, when you aggregate it at the total market level - so when you take the average cut across every stock on the market – is, in general, around market levels at the moment. So we're forecasting a decent market environment as long as commodity prices don't fall off a cliff because obviously that's a big part of the Australian market.

Ally Selby: Is there a number though that makes you feel a little bit uncomfortable? I said 7% before.

Peter Gardner: Over 10% is definitely challenging for a stock to maintain its dividends. If it was continuing to pay 10% every year, then that stock would be a great stock to invest in. So obviously the market's predicting that it's going to cut its dividends and that's why it's trading on a high yield.

Ally Selby: Over to you, Andrew. Do you agree? Is above 10%, I guess, a little bit worrying for you?

Andrew Fraser: In isolation, yeah. Over 10% is probably an area that would be a red flag for us. Markets are generally efficient, so stocks trading on a yield above 10%, it either reflects low growth or some pretty big concerns over the medium term outlook.

Double-digit yields on the ASX

Ally Selby: There are quite a few stocks on the ASX with double-digit returns right now. I know we talked about over 10% being a little bit of a red flag, but I want to know if any of those are sustainable. They're stocks like Centuria Office REIT, WAM Capital, Yancoal, IGO, Magellan Financial Group, Abacus Group, Platinum Asset Management, Helia Group, and Air New Zealand. Andrew, in your view, are any of those yields sustainable? And if not, why?

Andrew Fraser: Most likely not. On aggregate, a number of those stocks, we actually have owned in the past. Helia Group, which is a mortgage insurer, we have owned that in the past. It's not in the portfolio at the moment. We'd say that probably the current high-yield reflects the inherent leverage in that business. The fund managers, Magellan and Platinum Asset Management, typically those businesses, we like fund managers all things being equal. They're capital light, good cash converters, and typically pay good dividends. We exited both of those back in 2019. I think those yields now, Pete, you may agree that those yields reflect they've got some pretty big challenges in terms of fund outflows and I'd say at the moment those dividends are probably not sustainable.

Ally Selby: Do you agree, Pete? Are there any names on that list where you think, "Oh, maybe the yield is sustainable there?"

Peter Gardner: Helia is the one that would be the question mark over what's sustainable. We actually hold a small position in it in our fund. I agree with Andrew on the asset managers, as long as their funds are going out, then that obviously means their earnings are going to reduce in future years and they're going to have to cut those dividends. There's also a couple of stocks in there that have special dividends, so Air New Zealand and Helia Group, but also part of that dividend yield that you talked about is a special dividend and that's clearly management signalling that they don't expect that to necessarily continue going forward. The office REITs that you mentioned, they're also challenged in the current market environment, we think valuations probably have to fall another 10%. People are still working from home. It's not that easy to transfer an office REIT to become residential or some other kind of REIT. So yeah, we're not big fans of that group as a whole.

Are there any sectors with growing, sustainable yields?

Ally Selby: There are quite a few different sectors in there. Are there any sectors where there are growing sustainable yields, fingers-crossed at least?

Peter Gardner: That's a tough one. There are definitely stocks with growing sustainable yields, things like the technology sector and the healthcare sector, given their kind of growth elements of the market. But the challenge there is that their starting yield is quite low, so I'm not sure you'd go into them necessarily for their dividends because some of the yields are starting around 1-2%. And after saying that the high dividend yields at the other end of the spectrum, stocks like energy, materials, financials, they're all the more cyclical sectors that when the economy turns against you, they're likely to cut their dividends. So my answer to that would be there's no perfect stock or sector. You'd prefer to have a portfolio that had some of the growth stocks, some of the value stocks, some of the high-dividend stocks so that you can get at the portfolio level, a high-yield, which is also growing its capital as well.

Ally Selby: How about over the short term? Is there a sector that looks really attractive over the short term in terms of dividend growth?

Andrew Fraser: For us, that would be the insurers, and particularly the general insurers. They are enjoying a very positive macro backdrop which is supportive and we would expect that is an area where it is more likely than not that dividends not only sustainable in the long run, but actually over the short term we should see some increases in dividends.

Stock picks

Ally Selby: Okay. We talked about a lot of stocks today that don't have sustainable yields. I want a stock that you think does has a sustainable yield. Is there one which you are really excited about over the next 12 months?

Insurance Australia Group (ASX: IAG)

Andrew Fraser: For us, that'd be Insurance Australia Group. As I said, the macro backdrop has been extremely supportive for the general insurers over a reasonable period now. Since 2018, the industry has enjoyed substantial above average premium growth. They are beneficiaries of rising interest rates, the yields on their investment portfolios. They haven't seen these yields since 2006 to 2009. The way the insurance accounts work, there is often a lag between taking that increased premium upfront, taking appropriate provisions before you see that come back through in the form of increased profits and dividends. We're now getting to the point where that cycle has run quite some time and we'd expect IAG to not only maintain but lift its dividend. The other factor with IAG that makes it attractive from a dividend perspective, is they actually overprovision during the COVID pandemic. So they've actually got a lot of provisioning that they can unwind over the coming years, which is supportive of the dividend.

Ally Selby: Over to you, Pete, which stock has sustainable and growing yields over the next few years in your view?

QBE Insurance (ASX: QBE)

Peter Gardner: I'm going to agree with Andrew on the insurance sector and go with QBE. Similar to what Andrew's saying, premiums have been increasing. I received my last home insurance premium and it was up 45% on the last year. So they've been growing their premiums. Obviously, we've had a period of La Niña like except for the last year, the previous three years, and so they're able to grow those premiums strongly in that environment. The one risk is that we could be coming into another La Niña year. The Bureau of Meteorology said there's a decent chance of next summer being La Niña as well. And so we will wait and see. You generally don't want to predict the weather. And we think in the case of QBE, they're definitely managed a lot better from a risk perspective and so we think they're looking pretty good going forward.

Ally Selby: You're both bullish on insurers. Do you feel like there's anything, I guess, dangerous about sticking with consensus?

Peter Gardner: As a general rule, yes. We try and ignore what the competition's doing in a sense, so I guess you've got to be wary that if everyone's into insurers then they could become overpriced, but they don't look overpriced at the moment given where their current PEs are.

Ally Selby: Do you agree, Andrew?

Andrew Fraser: I would agree and look, we like QBE as well. If I look at IAG, it's probably not as well-liked as what you might expect. Only four out of 12-13 sell-side research analysts have got buys on the stock. Typically, people like to sell the insurers when there's a bad storm or some sort of catastrophe. The reality is that they recoup those short-term losses over the medium-term through jacking up premiums. And I've had the same experience where my home and contents car insurance has gone up year-on-year double-digits. Thankfully, we're shareholders of IAG, so I kind of get some of it back that way.

Ally Selby: Okay. Well, I hope you enjoyed that episode of Buy Hold Sell as much as I did. If you did, why not give it a like. Remember to subscribe to our YouTube channel. We're adding so much great content just like this every single week.

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Buy Hold Sell

Buy Hold Sell is a regular video series where Australia's leading professional investors share their views on Australian and Global Shares. This content is produced by Livewire Markets and has been syndicated to the Market Index website.

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