Dividends can be a great way to build your long-term wealth, especially with interest rates so low. Indeed, partly because of historically low interest rates, Australians have been moving capital into dividend stocks at an alarming rate. Those who chose top-notch dividend stocks some time ago have been enjoying strong capital gains, as well as a consistent dividend stream.
Spark Infrastructure Group (ASX: SKI) is a holding company that owns shares in other companies that own power infrastructure. Spark doesn’t have operational responsibility for building or maintaining the power lines, but does provide some of the capital required. Put simply, Spark borrows money to build power lines, then recoups that money from consumers, along with the interest, plus profit. If you live in certain parts of Melbourne, regional Victoria and South Australia, a big chunk of your power bill ends up in the pockets of Spark shareholders. The company has modest growth prospects, if any, and trades on a trailing yield of over 6.5%, albeit unfranked. Although solar panels are threatening the business model of companies like Spark, I think the network will continue to have value for some time to come.
Wotif.com Holdings Limited (ASX: WTF) is a quality business that no longer has great growth prospects. When I started drafting this article, shares were trading under $2.40, and I expected the company to yield over 8% in FY 2014. Inexplicably, the share price shot up over the last two days to about $3, giving the company an expected FY 2014 yield of over 6.5%
Wotif owns the eponymous hotel (and flight) booking website and would be a very attractively priced stock at under $2.20. Investors should keep Wotif on their watchlist, because although the company is no longer growing, its substantial free cash flow should continue to fund a very healthy dividend for years to come (even if that dividend does decline). At current levels, I think Wotif shares are too expensive, as the company is unlikely to consistently grow profits over the coming decade. However, it’s clear that the market was undervaluing the company recently, and I think it is a reasonable play at below $2.50 (although I want it cheaper).
Insurance Australia Group Limited (ASX: IAG) is Australia’s largest home and contents insurer. The company recently raised capital at $5.47 per share to fund a major acquisition, expanding its business significantly. I’m glad I suggested to readers that they shouldn’t apply for shares under the share purchase plan, because the share price has now dropped to those levels. The company is currently trading on a trailing yield of about 6.9%, although I think it would be unrealistic to expect the company to yield that much in FY 2014.
Nonetheless, at current prices it is reasonably likely that shares will yield around 6% in FY 2014. As I wrote previously I would prefer to buy IAG after an unlucky year, rather than a very profitable year, as was FY 2013. One of the reasons I’ve generally avoided property insurers is concerns that climate change might make their businesses less profitable.
However, in a recent interview with CNBC, Warren Buffett indicated that climate change has not had a noticeable impact on his insurance operations. “I think the public has the impression that because there’s been so much talk about climate that events of the last ten years from an insurance standpoint in climate have been unusual,” he said. Finishing: “The answer is they haven’t.”
After its recent sudden rise in share price, Wotif must come down a bit to be considered a good buy. If you can buy shares at around $2.20, you should be on solid ground. Spark Infrastructure has a very defensive business, but no particularly compelling growth opportunities. I think a share purchase at under $1.60 should beat the market, but I’d steer clear of the company until it’s clear how they will adapt to the increasing penetration of rooftop solar. Finally, IAG may look attractive around current levels, but investors should remember that the dividend may well be reduced – it would be worth a closer look at below $5 per share.
Generally speaking, I suggest investors focus on the underlying business, rather than the dividend. However, each of these three companies does have a decent quality underlying business, and they all deserve a spot on your watchlist. High dividend yields are undoubtedly attractive, but I prefer to invest in companies with very strong growth prospects, even if they pay slightly lower dividends.
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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article and (usually) welcomes feedback from readers.