Many leading financial commentators are starting to become concerned that investors' 'search for yield' is forcing them to take on significant risk without realising the implications.
Now, you might think that means buying some penny mining stock or a $300 million small-cap offering a trailing 8% dividend yield.
However, personally, I think the biggest risk is less obvious, but far more concerning.
It's at the big end of town. In Australia's blue-chip stocks.
You see, too many investors assume because they buy a blue-chip stock like Commonwealth Bank of Australia (ASX: CBA) or Telstra Corporation Ltd (ASX: TLS) that they've automatically made a prudent investment decision. But here's an interesting fact: During 2008 Commonwealth Bank shares fell 53%!
Indeed, the further a company's share price moves away from its intrinsic value, the riskier it becomes.
Make no mistake.
Intrinsic value is the fundamental value ascribed to a stock. It is usually a range of values.
For example, if I determine Coca-Cola Amatil Ltd (ASX: CCL) shares are worth between $11.00 and $11.50 based on a number of robust valuation models – which use my (subjective) growth assumptions – yet the market price of the shares is currently $10.49, I'd say it has intrinsic value.
Determining a stock's truth worth is fraught with error and intensely subjective.
However historical performance coupled with the theoretical underpinnings of intrinsic valuation methodologies support the practice of buying cheap shares.
Indeed, it's important to remember an asset (today) is worth the sum of its future cash flows. Not dividends paid to shareholders but cash flows to the company from its customers.
Are Woolworths, National Australia Bank Ltd (ASX: NAB) and Telstra a 'Buy'?
With that in mind, here's what you need to know about these three blue-chip stocks…
Woolworths
As Australia's most profitable supermarket chain, you'd be mistaken for thinking the market is prepared to pay an above-average price for Woolworths shares. However after falling 23% in the past year, Woolies shares have moved back into a much more compelling valuation range and are currently offering a 4.7% fully franked dividend yield. Whilst it's not at bargain prices, investors could do worse than add Woolies to their portfolios for its dividend yield and relative safety.
National Australia Bank
All the big banks have pages upon pages of complex financial jargon and tables and graphs reserved only for a very select audience, so I firmly believe it's impossible to pinpoint the exact worth of their shares (although your advisor will likely to try convince you otherwise!). I prefer to keep it simple. For NAB – Australia's accident-prone big bank – I find it very difficult to justify its current market price. It's the worst performer across almost all of my relative valuation measures, yet continues to trade over 2x its book value. Given where we are in the market cycle, its track record and valuation, I think NAB's share price is being artificially inflated by the search for yield and should be avoided at this point in time.
Telstra
As the leader of Australia's telecommunications industry, Telstra is able to drive enviable cash flows which can then be used to reinvest in new growth areas or pay out dividends to shareholders. However, whilst it is undoubtedly one of the best income stocks on the market, it's hard to envisage it beating the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) from today's prices. I'd be tempted to fill the coffers on Telstra's shares slightly over $4.00.
Buy, Hold or Sell
