Over the past few years as interest rates have sunk lower and lower, the share price of Telstra Corporation Ltd (ASX: TLS) has marched higher and higher. In fact, back in late 2010 investors could have purchased the stock for around $2.60 a share. Today, Telstra is trading at $5.80 – a gain of 123%!
What has been happening is that many investors have been desperately seeking income by switching out of term deposits and the miniscule interest rates they offer and buying in to stocks such as Telstra to access the attractive fully franked streams of dividends.
One major flaw in this strategy
Unfortunately, many investors could be about to experience a nasty lesson on the risk of blindly chasing yield. The total shareholder return (TSR) an investor receives from owning a share of a company is the sum total of any dividends received PLUS the change in the share price over the period of ownership.
Worryingly, many investors appear to have neglected to consider the price they are paying for shares and the risks that the stock is overvalued and could fall; rather they have focussed solely on the yield they will receive.
Put another way, receiving a 5.2% dividend yield on your investment isn't a great outcome if the share price declines by 20% from your purchase price!
Better alternatives
Admittedly a yield of 5.2% – which is Telstra's forecast yield in FY 2015 – certainly appears attractive compared with a term deposit, however like I said it's the TSR which really matters.
Here are five stocks that not only have forecast yields above 5.2% but which I believe also have more appealing long-term earnings growth potential.
- JB Hi-Fi Limited (ASX: JBH) has a fully franked forecast yield of 5.5% and a forward price-to-earnings (PE) ratio of 12x. The company should benefit from any improvement in consumer sentiment and also its expansion plans.
- Automotive Group Holdings Ltd (ASX: AHE) is forecast to grow earnings and increase its dividend in FY 2015. Based on consensus forecasts, this leading car retailer is trading on a fully franked yield of 6% and a PE of 12.4x.
- Villa World Ltd (ASX: VLW) is in a sweet spot with house prices in Australia at record highs making now a good time for investors to own property developers. Management is guiding the market towards growth in profit before tax of over 5% in FY 2015 which suggests the historic metrics of a trailing fully franked dividend yield of 8.2% and PE of 8.5x will understate this year's results.
- DWS Ltd (ASX: DWS) is an IT services business which along with the rest of the sector has been struck with reduced demand and spending from its customers. While the move to SaaS and cloud based services also creates some headwinds it also creates opportunities for the group. With a forecast fully franked yield of 8.5% and PE of 10.4x the risk-reward situation looks to stack up.
- Having a diversified portfolio is vitally important. One way to instantly increase your diversification is by using a listed investment company. With WAM Capital Limited (ASX: WAM) trading on a trailing fully franked yield of 6.7%, this stock would offer investors both an appealing yield and exposure to a portfolio of emerging growth stocks.
