Leading economists at Australia and New Zealand Banking Group (ASX: ANZ), Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd (ASX: NAB) expect two interest rate cuts in 2015.
That's terrible news for term deposit holders but for share market investors it means dividends will once again be the focus of attention in the year ahead.
Indeed with term deposits offering as low as 2.5% per annum now, imagine what the returns will be if the cash rate drops to 2%, as economists are predicting.
Given the outlook, right now seems a great time to transition money from lacklustre savings accounts into dividend-paying shares…
It makes perfect sense, doesn't it?
Why would an investor accept say 3% on a term deposit, when they could get over 5% (sometimes with franking) from the sharemarket?
Unfortunately it's not that simple and even the best dividend stocks, such as the big banks, carry significant capital risk.
Meaning a 5% or 10% drop in the banks' share prices could quickly wipe out the benefit of a bi-annual dividend.
Currently NAB boasts the largest dividend yield.
At today's price of $35.20, its shares trade on forecast fully franked dividend yield of 5.9%. By adjusting for franking credits, the dividend yield becomes a whopping 8.4%!
Buy, Hold or Sell?
Dividends are only part of an investment thesis and given NAB's troubled past, valuation and ongoing exposure to the UK and USA, it's probably better to wait for a cheaper price before hitting the buy button.
Whilst analysts are expecting a bounce back to profit growth in 2015 (following huge write-offs in 2014), shares currently trade on a price to book ratio of 1.86. Given its poor profitability, savvy investors should demand a much lower price before buying (below 1.3 times book).
In addition if bad debts start rising (NAB itself is predicting unemployment to climb to 6.6% in the next 12 months) the bank's earnings per share will be adversely affected.
So although they appear cheap on a dividend and price-earnings (P/E) basis, if bad debts rise, earnings drop and investors' predilection for dividends reverses, NAB will likely experience significant selling pressure. At today's price, it's not a buy.
