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Rush for yield is on

With the S&P ASX 200 Index (Index: ^AXJO) (ASX: XJO) rising over 22% in the last twelve months, falling deposit rates, an unprecedented flood of money is flowing into the Australian equity market.

And evidence appears to show that investors are focusing on our top 20 stocks, including the big four banks, Telstra Corporation  (ASX: TLS), Wesfarmers Limited (ASX: WES), Woolworths Limited (ASX: WOW) and AMP Limited (ASX: AMP). All are well-known companies, and probably most importantly for the majority of retail investors, paying decent fully franked dividends above rates available in term deposits, and with the added bonus of franking credits.

We’ve seen the majority of those companies make new 52 week highs in the last week or so, as demand for those stocks pushes prices up. The issue for Foolish investors is that many are starting to look expensive, and future capital growth may be low. As an example, Woolworths is expected to grow earnings at low single digits, but its PE ratio is rapidly closing in on 20.

In fact, the recent price rises appear to have become detached from company earnings, and we could see these companies’ share prices come back to the pack, should the market pull back at some stage. The term “Blue-chip dividend bubble” has been coined, explaining the increasing divergence between reality and the rapid rise in share prices of the majority of the top 20 stocks.

Investors need to be aware that share prices can fall and the drop could be larger than the dividend they receive, and the Top 20 stocks’ share prices may not be as resilient as investors are expecting. After all, Woolworths shares fell to below $24 in October 2011 – that’s a long way away from the current price of around $35.

Foolish takeaway

Investors seeking yield may want to consider looking outside the Top 20, for companies that are not as expensive, but still paying good dividend yields. Discretionary retailers, building materials, media, smaller telecommunications, utilities and property companies may be worthwhile sectors to consider.

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More reading

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool writer/analyst Mike King owns shares in Woolworths.

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