Have high yields lost their appeal?

High-yielding dividend stocks have attracted investors en masse in recent years due to their appealing returns – particularly in comparison to those offered by other investments, such as term deposits.

As a result, each of the big four banks, along with Wesfarmers (ASX: WES), Woolworths (ASX: WOW) and telecommunications giant Telstra (ASX: TLS), have all soared in price and increased their dividends accordingly.

However, many analysts are now warning that such stocks have become overpriced and could be at risk of pullbacks. We saw ANZ (ASX: ANZ) and NAB (ASX: NAB) fall around 4% each on Thursday last week as they traded ex-dividend, demonstrating the extent to which the companies’ share prices have been bolstered by their yields.

According to Perpetual’s head of market research, Matt Sherwood, Australia’s banks are amongst the most expensive in the world and are currently trading at a forward P/E ratio of around 14. This is the same level as previous cycle peaks, such as in 1999, 2001, 2007 and 2012.

Sherwood warned that “investors need to be very guarded about thinking of these companies as having riskless earnings.” That is, although a company might offer a high yield, investors must assess whether or not they will be able to maintain or even increase those payments.

It is looking unlikely that the banks will be able to maintain their distributions in the short-term at least, as they will be required to keep more capital in reserve in accordance with pending rules by the Australian Prudential Regulation Authority (APRA).

What’s more however, is that their share prices are also likely to fall as a result, which would reverse any gains realised from the dividend payments.

Foolish takeaway

Although Commonweatlth (ASX: CBA)Westpac  (ASX: WBC), ANZ and NAB have appealing dividend yields, the shares themselves are anything but cheap. Instead, investors should be looking for other quality companies trading at discount prices, which also increases your chances of recognising capital gains.

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