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Friday, 23 June 2017
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10 Income Stocks you have to own!

One of things I abhor about modern financial advertising is Click Bait. The pathetic headlines designed to get you to click on an Ad. Its insulting and quite honestly, I don't want to take advice from someone who is trying to 'snag' me.

In equities the most common click bait, and some newsletters have been running these click bait Ads for years now, is this one - “The Top Ten Dividend stocks you have to own!”. Interchange “Dividends” with “Income” at will.

I can’t put up the graphics of these atrocious Ads without dobbing in all the Lemmings in my space but you know the ones. I should do it myself of course, they have obviously found this one line to be the most commercial advertising there is and I am missing out for not playing their pathetic game. Even the good guys are doing it…(yes there are good guys and bad guys in our space). But I have yet to debase myself.

So let me save you time. I have had one of my MIGS (my graduates - Maverick, Ice and Goose) click around and here's what’s behind the click bait - “The Top 10 income stocks you have to own”. We  quickly found eight Ads, drilled down through the marketing and found this list of the “Top 10 Income Stocks you have to own”.

So that’s the lightweight stuff. 

We have also done a bit of digging for you in an attempt to identify the stocks that real life income focused managed funds and LICs hold. We found 14 funds. These people actually put real money in income stocks.

Out of 14 funds that are focused on Income the following stocks have turned up more than once with the number of funds holding each stock shown on the left. This will give you an idea of the most common inclusions in an income fund

It’s a predictable list focused on big stocks. This is because generally speaking income investors are cautious about equities. Many would prefer to earn a risk free return in bonds of around 6-7%, but that is no longer available unfortunately, so many have come out of the woods and have reluctantly had to buy equities and take risk. When they do the tendency is to gravitate to ‘safe’ equities as bond proxies which means “big” income stocks get the most attention. We can and should debate whether “big” equals “safe” of course and we can tell that from the performance numbers of the same list of stocks below:

As you can see, big is not safe. It may be safer but it’s not safe. Look at the underperformance of the banks over three years compared to the ASX 200 and the ASX 200 Accumulation Index at the bottom. Admittedly the stock returns don’t include Dividends – I can’t get the total return numbers for individual stocks but income aside you can probably compare to the ASX 200 and the share price does reflect what has happened to an investors capital. Also:

  • Both WES and TLS have been going down and underperforming on every level.
  • WOW has underperformed 33% in three years.
  • You will see above that a lot of the funds hold CSL. Yield of 1.0%. How does that get in there? It gets in because all portfolio managers want some growth and the truth is that after all the shenanigans, it turns out that a dollar of income after tax is the same as a dollar of capital after tax. So depending on your risk profile you will include lower yielding growth stocks in an income portfolio if you have a higher risk profile and want to give it some “Pep” and have a better than boring chance of outperforming the market.

So big is not safe because as it turns out, relative to a risk free return there is no “safe” in equities whether you are focused on income or not, equities come with volatility which is in complete contrast to the ‘risk free’ return some were used to. The volatility is also getting worse (QBE fell 10% yesterday, WOR fell 20% on recent results). It has got to the point that if you really are focused on income without taking risk you really shouldn’t be lured out of the woods into equities at all. 

If you really are income only focused and don't want to risk your capital don't listen to anyone telling you its safe. In which case you might actually be better off if you adjust your expectations, if you simply rationalise a 2% return on your risk free capital, rather than risk your capital. Everyone will tell you how great equities are but it’s a personal preference thing. If you can’t afford or mentally handle losses, you should probably budget on less. Sometimes you will do better, have a better life, spending your capital rather than risking it. There are no guarantees in equities and in the worst cases the equity market can destroy you, it fell 56% in the GFC. Corrections (10%) are an annual thing. You have to time things in equities, and in the face of that difficulty, volatility and risk, there is no point coming out of a risk free environment for a couple of percent in extra yield.

If happiness is expectations met, just adjust your expectations. The lower they are the happier you’ll be.  

THE TOP 15

So let’s look through the top 100 stocks that have a yield over 6% and see whether we can identify the top dividend stocks you simply have to hold - here are all stocks in the ASX 100 yielding over 6% including franking.

I’m going to use a process of elimination and eliminate:

  • TLS – no growth, NBN uncertainty, horrible trend.
  • WES – Sector under siege.
  • FMG – Not an income stock. Too volatile.
  • AZJ – Geared to resources, not reliable.
  • CWN – Earnings too volatile.
  • CCL – Horrible trend…one day it will turn. Looking to time the buying.
  • BEN and BOQ – If you already have the banks you can pass on these – they are more volatile and need timing.
  • HVN – Too cyclical to rely on. Looking like a trade one day but not an income stock.

That leaves us 9 stocks:

Best of the rest – here is a list of stocks with over 6% gross yields in the second biggest 100 stocks (the bottom of the ASX 200). These are at the conservative end of the scale (couple of REITs) and I have left PTM in there because it has fallen so far but they are invested in a lot of emerging market and Chinese tech stocks which should pay off in the end:

That's 15 stocks. 

TAKING A BIT MORE RISK

Here is a list of the other stocks that appeared in a number of the income funds we looked at – I would point out here that some of these stocks have high yields because they are terrible performers and a lot of them as you will see are cyclical stocks that you cannot rely on. So this list is certainly not a recommendation but it does make the point that there is a big difference between a high yielding stock and an income stock. Its called the Yield Trap. Buying rubbish stocks because they have a big yield. Not all these are rubbish but, to weed out the stocks that conservative income focused investors should avoid, go through this quick check list:

  • Anything that yields over 10% generally doesn’t. Usually it’s because the share price has fallen rapidly and the forecasts are behind the curve and will be downgraded.
  • If you want to sleep at night avoid cyclical stocks, media, retail, builders.
  • Some smaller companies pay big yields because their CEO has a huge holding. You might check that. It might suggest a stable earnings stream but possibly it’s just a small volatile company with a greedy CEO.
  • Yield isn't everything. Look at ROE, price versus intrinsic value, reliability of earnings, balance sheet, broker opinions, franking - all these things can be snapshotted using our STOCK BOX. If you can combine these factors with yield...all the better. But note that quality is everything, yield is secondary.

I hope naming some of the income stocks and giving you a few ideas has helped, but if you really are an income focussed investor let me make this very important point. 

If you are a conservative retiree interested only in income, are living off that income and you really don't want to take risk or can't afford to, you should look beyond equities to Hybrids, term deposits or bonds (there are hundreds of funds that provide those exposures)

A lot of our clients at the "use it but don't lose it" end of their investment cycles do just that. They hold a lot of hybrids with our guidance. We rotate about a bit as new issues come on board, and we have to watch for them getting overpriced, but generally speaking they are earning around 6% on their money with very little real risk. You might do the same thing if you are conservative. 

And despite what you might read from some fixed interest experts, the issue with Hybrids is not the price, the risk and timing, the main concern is an unlikely but possibly seismic moment of significant financial turbulence like the GFC. Whilst almost all hybrids survived many of them had heart stopping dips. Most recovered and there was no harm done. But there were dips that would have sent conservative investors to their cardiologist, dips that in hindsight created some great trading opportunities, buying Macquarie prefs at 60c in the dollar was one of the best. Sometimes nothing is safe. At those moments cash is the only option. Far better you sacrifice 4% of income than you lose 56% of your capital. 

So whilst we in the equities game are trying to lure you in as income investors, the reality is that, as any Yank will tell you, bonds (and hybrids) are for income, equities are for growth and unless you are prepared for that, you should probably leave the equities out of it. 

But for those that do have some risk appetite, the truth is that income funds more often than not outperform growth funds because they tend to be invested in lower risk, larger, higher quality stocks that weather the dips a lot better than growth stocks. But it does need managing (pruning the weeds is the main issue) and is not set & forget as many conservative investors think it should be.

 

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