The last few years have been good to income focussed securities. When it comes to the stock market, 'income' is a very loose word. For simplicity, I tend to think there are two types of income stocks, a) stocks that are ordinary shares that have a relatively high dividend but expose the investor to ups and downs in the stock market and b) stocks that are specifically structured for income and provide little or no room for capital growth.
A strategy that selects ordinary shares is the Dogs-of-the-Dow strategy. In my previous role, we ran the Australian version of this strategy since the GFC and the returns have been truly eye-popping. I have been waiting for mean reversion, which would mean that resource stocks would need to outperform financials, however it hasn't happened and clearly the markets hunt for yield has continued.
The main focus for this post however is stocks structured for income. I keep on top of most of these stocks and they can be found in the tables at the back of the Australian Financial Review (AFR) under Interest Rate Securities. There are various classes of securities including hybrids and convertibles.
Warning: it is extremely important to note that an income security does not necessarily mean safe or similar to a term deposit. Two cases illustrate the point perfectly:
a. PaperlinX SPS Trust (PXUPA). Issue Price: $100. Current Price: $6.90
b. Elders hybrids (ELDPA). Issue Price: $100. Current Price: $27.00
Some of today's stocks trading at $100 or thereabouts will possibly be donkey's in the future. Seth Klarman wrote an excellent piece for Forbes in 1992 called Don't Be a Yield Pig.
Moving on.
When considering this area of the market, two sets of analysis needs to be undertaken. First, understand the structure of the stock and second the underlying fundamentals of the issuing company. Not necessarily in that order.
The structure of each issue has its own terms and conditions. Some pay a fixed rate, others a floating rate. Some are cumulative, some are not. Some have a fixed maturity date, some are perpetual. Most (but not all) have a 'face value' of $100. Personally, I keep a spreadsheet of these stocks and periodically update the prices, new issues and update base interest rates. This makes the job manageable. I calculate a current yield and yield-to-maturity. Current yield is the current interest divided by the current price. Yield-to-maturity takes into account the current yield and any capital gain or loss.
I am of the belief that some investors are not considering yield-to-maturity when paying above face value for some of the securities. Many of the stocks don't have maturity dates, so yield-to-maturity is meaningless (unless you assume they may be bought back).
There are many more.
My list is not complete, however of the 55 I track, the average current yield is 6.8% p.a.. Two years ago, that figure was (from memory) closer to 9% p.a.. My argument back then was the long term combined income and growth return from the share market was anywhere from 9-11% p.a. depending on the time period and market, so making the majority of that from a collection of income stocks without having to worry about growth seemed sensible.
I find less bargains these days, however it is an interesting area that is constantly growing and I am sure it will produce some more good buys in the future.
Kristian
Disclosure: own MXUPA
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