Australian stocks are renowned for their big dividend yields.
Our biggest blue-chips can pay 5% or more in a dividend yet still manage to grow earnings at a double-digit rate. Chuck in franking credits for self-managed superannuation funds and you've got a fantastic investment case.
However with the S&P/ASX200 Index (INDEXASX: XJO) up 37% in the past three years and the official interest rate riding at its lowest level in many decades, we've witnessed big dividend stocks climb rapidly. So much so that many are now overvalued.
For example, National Australia Bank Ltd (ASX: NAB) and Woolworths Limited (ASX: WOW) both yield grossed-up dividends greater than 5% and have had their share prices climb 48% and 43%, respectively in the past three years.
However, between 2011 and 2013, their earnings per share rose just 2% and 6.1%, respectively. In my opinion, it's not enough to justify their current share prices.
Australia and New Zealand Banking Group (ASX: ANZ) and Insurance Australia Group Ltd (ASX: IAG) are two other companies which have made plans to grow their businesses throughout Asia. Each pay a spectacular dividend and both trade on a relatively good valuation.
ANZ has however, like NAB, benefitted greatly from falling provisions and investors' ongoing demand for fully franked dividends. As much as I like its prospects moving forward, I'd rather wait and purchase shares when bad debts are rising and earnings (and its share price) come under intense selling pressure.
IAG recently announced a strong set of full-year results and its share price has reacted accordingly. QBE Insurance Group Ltd (ASX: QBE) on the other hand, has continued to deliver unimpressive results, yet its share price popped over 4% today when it was first released from its trading halt.
I can't explain with certainty why its shares popped but I know one thing's true about insurance stocks: The best time to buy is when payouts rise drastically or they are hit with unexpected costs. Although IAG is a well-run business and its share price could take-off, it has been on the opposite end of the spectrum and, as a result, profits are flying higher. I'm waiting on the sidelines (for now) until the trend reverses and I can pick up shares even cheaper.
The last company to offer a grossed-up dividend yield over 5% is Rio Tinto Limited (ASX: RIO). I hope it will pay a grossed-up dividend equivalent to 5.08% in the coming 12 months, as its board and senior management contemplate what they'll do with the cash gained from recent cost cuts and capex spend. I think they'll use it to increase the final dividend.
At today's prices I also think Rio Tinto is a good buy.
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