The market is steaming higher this week, led by the banking sector. With Westpac Bank (ASX: WBC) touching an all-time high, it has joined an elite group of companies with market capitalisations of greater than $100 billion. Other members include BHP Billiton (ASX: BHP), Commonwealth Bank (ASX: CBA) and Rio Tinto (ASX: RIO)
It has been a stellar run for bank stocks since the start of the calendar year as investors have chased their high fully franked dividend yields. This has resulted in bank stocks significantly outperforming the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO). This "chase" has forced up the share price of bank stocks to record highs, with the exception of National Australia Bank (ASX: NAB), which is still a long way from the near $45 high it reached in 2007. NAB has been making up some ground though, rising the most since January as the chart below shows.
Market yield vs bank yield
The forecast 2013 dividend yield for the S&P/ASX300 Industrials excluding financials according to broker Goldman Sachs is 3.7%.
With the four major banks still yielding around 5%, even after the significant share price appreciation, there is an understandable allure for investors to potentially keep "chasing" this high yield.
Foolish takeaway
There are a number of reasons a stock might sell with a higher yield. Two reasons, both of which are relevant for banks, are slower growth and risk. A slower growing company has less need to reinvest its earnings – this means the company can pay more of its earnings out as a dividend. The investor is effectively being compensated for lower capital gains potential with a higher yield. Secondly, the riskier a businesses is, the more "risk premium" an investor should demand. Banks leverage their balance sheet to lend out many times their capital. This is a risky business. Bank investors should rightly get compensated with a higher yield for taking on that risk.
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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 contributor Tim McArthur does not own shares in any of the companies mentioned in this article.
