The Reserve Bank of Australia’s surprise 50 basis points interest rate cut this month strengthens the case for investing in high-yielding stocks. Why get 5 per cent in a bank term deposit, less if rates are cut again in the next few months, when Telstra offers 8 per cent fully franked and growth potential?
Of course, the main appeal of term deposits is capital security. Getting 6 per cent in a government-guaranteed term deposit last year and avoiding sharemarket volatility was a no-brainer. Self-managed superannuation funds, in particular, have been heavily overweight with cash in their portfolios – a reason why their aggregate performance has been much better than commercial and industry funds.
Some of that excess cash needs to be put to work. I expect markets to grind higher, possibly towards 4800 points by year’s end, before a stronger market next year. The main pieces for the next bull market are falling into place: a slowly recovering US economy, more signs that China is improving and domestic interest rate cuts that should lift consumer sentiment and spending.
Yes, many risks remain. Europe is a mess and there is a significant risk of a US slowdown if its politicians cannot agree on budget cuts. In Australia, the reluctance of banks to pass on full official rate cuts might weigh on sentiment and our dollar most will likely stay stronger for longer. A recovery needs more time; probably 12 to 18 months before more investors believe in a rally.
Given this outlook, the best sharemarket strategy remains buying reliable high-yielding stocks. Twelve months ago, that strategy should have been based on large defensive stocks such as Telstra and Commonwealth Bank. Readers who seek high-yield blue-chip ideas should follow the AFR Smart Investor Cash Club, which I update for that magazine every six months after the reporting seasons.
The defensive yield strategy has served investors well but now is the time to rebalance portfolios cautiously towards stocks that offer yield and capital growth to position portfolios for a stronger market later this year and to safeguard against higher inflation eating into real returns from term deposits.
Do not dump Telstra or CBA; rather, look further afield to blue-chip stocks in more cyclical industries, or to well-run small and mid-size companies that offer reliable yield and growth potential.
Wealth management group BT Investment Management is an example. Weak equity markets and acquisition costs led to a 24 per cent drop in net profit in the first half. At $2.13, BT has a prospective fully franked yield of 6.4 per cent next financial year, rising to 7 per cent the year after, on consensus analyst forecasts. An improving sharemarket will lift its funds under management.
BWP Trust is another mid-cap yield idea. It is the only Australian real estate investment trust (A-REIT) that offers pure exposure to the bulky goods sector. Not all retail sectors are weak: the do-it-yourself hardware market is benefiting from home renovations. Consensus forecasts have the Bunnings Warehouse Property Trust yielding above 7 per cent next financial year.
The strongly performed NIB Holdings is expected to yield at 8 per cent next financial year, fully franked. The private health insurance group is trading near its 52-week high of $1.70, yet still on a prospective price-earnings (P/E) ratio of about 12 times, which looks reasonable for a well-run company. E.L. & C. Baillieu and JPMorgan have “buy” recommendations on NIB.
GWA Group also stacks up as a mid-cap dividend play. Like other manufacturers, it suffers from weakening housing construction and less demand for its fixtures and fittings. Bad news is priced into its stock: at $2.08, GWA is trading near its 52-week low, on a current P/E multiple of 10 times and yielding 8.6 per cent fully franked. It will look cheap below $2.
Another well-run manufacturer, GUD Holdings, should yield more than 7 per cent, fully franked next financial year, and trade on a P/E of about 12 times, consensus analyst forecasts show. GUD owns industrial and consumer brands, such as Sunbeam and Oates cleaning products. It faces weak markets and most likely modest earnings growth for some time, but a solid yield should tide investors over.
Investors with more risk appetite might consider micro-cap stocks, such as Wellcom Group and Regional Express Holdings (REX). The marketing group Wellcom should yield almost 7 per cent fully franked next financial year. The regional airline REX should also yield above 7 per cent, fully franked, although I have never been a big fan of airline stocks given that industry’s volatility and poor return on equity.
The author owns Telstra and CBA shares.