ASX banking shares like Commonwealth Bank of Australia (ASX: CBA) are well-known for their high dividend yields.
The high yield is partly because of their high dividend payout ratios but it’s also down to their low valuations. For example, Commonwealth Bank is trading at 16x FY20’s estimated earnings, which is cheaper than most other blue chips (except other large banks).
The two factors together mean that some investors may think of ASX banks as good value for their earnings and a good income idea.
Commonwealth Bank currently has a grossed-up dividend yield of 7.6% based on its $4.31 dividends per share over the last 12 months.
That means that to get $12,000 a year in dividends, or an average of $1,000 a month, from Commonwealth Bank it would take just under $158,000 worth of CBA shares to achieve the income goal.
Westpac Banking Corp (ASX: WBC) has an even bigger grossed-up dividend yield of 9.7%, so you’d only need around $124,000 of Westpac shares to get that level of income.
However, I hope you’re seeing the problem with this strategy.
Unless you have a multi-million dollar portfolio, having $158,000 of just Commonwealth Bank shares or $124,000 of Westpac shares is far too much in just one or two businesses in the banking industry.
There are risks with banks, that’s why they trade at lower valuations compared to most other businesses. I think their growth prospects are quite benign these days with an uncertain property market and rising mortgage arrears.
Whilst it’s certainly possible to generate a solid level of income from banks, it would not be my preferred dividend strategy.
For income I’d much rather invest in businesses that have lower yields but are growing and operate in solid industries like these top ASX shares.
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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. 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 Scott Phillips.