Dividend report card: National Australia Bank Ltd.

Credit: NAB

With interest rates falling, high yield stocks continue to appeal to a large number of investors. Furthermore, while inflation currently stands at just 1.5%, a loose monetary policy could leave income investors struggling to obtain a real return on their cash balances. Therefore, higher yielding stocks could plug a key hole over the medium term.

Among the highest yielding stocks on the ASX is National Australia Bank Ltd. (ASX: NAB), which currently yields 6.9%. That’s 230 basis points greater than the wider index’s yield and is in part due to the bank increasing dividends per share at an annualised rate of 5.7% during the last five years.

However, there are concerns among a number of investors that such strong dividend growth may prove to be a thing of the past. That’s because the Australian economy could bet set for a challenging period, with the prospect of a recession being a threat. This, plus higher demand on the capital held by major banks, could put a squeeze on profitability and shareholder payouts across the sector.

Despite this, NAB is still forecast to increase its bottom line at an annualised rate of 8.6% during the next two years. A key reason for this is a reorganisation of its business which is set to see the disposal of non-core assets. They have offered a rather unappealing risk/reward ratio in recent years, with NAB’s UK operations and also its stake in Great Western being examples. Furthermore, NAB is shifting its focus towards faster growing segments such as home loans and SME where demand for borrowing is expected to remain buoyant over the medium term.

Certainly, a recession would hurt NAB’s financial performance, but after raising $5bn earlier this year via a placing it now has a tier 1 capital ratio which places it in the top quartile on an international comparison. As such, it appears to be relatively well-placed to not only survive an economic downturn but to also strengthen its competitive position as it seeks to become leaner and more profitable over the coming years.

Moreover, NAB’s valuation appears to take into account the risks which it faces, with the company’s shares trading on a price to earnings (P/E) ratio of 12.6. That’s lower than the ASX’s P/E ratio of 15.4 and, with NAB having a price to book value (P/B) ratio of 1.4, it appears to offer fair value for money when its forecast growth rate is factored in. And, with dividends per share being covered 1.3 times by profit, it appears to have adequate headroom to increase dividends at a higher rate than inflation even if the forecast earnings growth rate is downgraded in the coming months.

So, while NAB’s share price performance has disappointed this year as it has declined by 15%, it could be a relatively appealing place for income investors to allocate capital over the long term.

Despite this, there is another ASX stock that I believe is an even better buy than NAB.

It has recently been named as The Motley Fool's Top Dividend Stock For 2015 and could make a real impact on your bottom line in 2015 and beyond. And, in time, it could help you retire early, pay off your mortgage, or simply enjoy a more abundant lifestyle.

Click here to find out all about it - doing so is completely free and comes without any obligation.

Motley Fool contributor Peter Stephens has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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