What a difference a year makes. This time last year, investors in QBE Insurance Group Ltd (ASX: QBE) were fairly miserable, with the company's share price slumping in the second half of 2013 before offering little in the way of growth potential. Since then, the insurer's share price has surged by 28% as its new strategy of divesting non-core assets and focusing resources on lower risk, higher return divisions has gained in popularity with investors. And, with QBE turning from loss into profit over the last couple of years, increased optimism has been backed by improved financial performance.
Of course, Wesfarmers Ltd (ASX: WES) has been something of a polar opposite to QBE in the last year. Its share price has fallen by 7% as a more challenging supermarket sector has weighed heavily on investors' minds and, with Wesfarmers reporting a fall in profit over the last year, their concern seems to have been valid.
Despite this, Wesfarmers remains an appealing income stock. For example, it currently yields a fully franked 5%, which is higher than the ASX's yield of 4.5%. Furthermore, the company's conglomerate structure and multitude of brands provides it with a degree of shelter from the harsh economic wind that is present in the supermarket sector and, looking ahead, this means that Wesfarmers is set to increase its bottom line at an annualised rate of 8.1% during the next two years. As a result, dividend growth is forecast to beat inflation, with dividends per share due to rise by 2.5% per annum over the next two years.
Meanwhile, QBE offers a rather disappointing yield when compared to that of Wesfarmers, with it yielding 3.5% (fully franked). However, QBE's new strategy is set to stimulate its bottom line, with earnings growth of around 26% per annum over the next two years set to push dividends higher at an annualised rate of 15% during the same time period. As such, QBE trades on a forward yield (using financial year 2016's projections) of 4.2%.
While this figure remains behind that of Wesfarmers, it is worth noting that QBE has a far lower payout ratio than Wesfarmers. In fact, Wesfarmers' payout ratio is set to hit 91% next year, which leaves only a relatively small amount of capital for reinvestment and indicates that dividends may not increase unless earnings growth is sustained. QBE, however, has a payout ratio of just 55%, which indicates that its dividends could move substantially higher with or without strong bottom line growth.
Surprisingly, after its strong share price performance, QBE still trades at a small discount to the wider insurance sector, with it having a price to earnings (P/E) ratio of 18.3 versus 18.4 for the wider sector. This is the same rating as Wesfarmers and, while this may lead investors to consider them equally valued, QBE's much stronger earnings growth rate means that its price to earnings growth (PEG) ratio of 0.71 is far more appealing than Wesfarmers' PEG ratio of 2.25.
So, while Wesfarmers has a higher yield, QBE is better value and has much greater scope to increase dividends over the medium term.
