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David Stevenson Nov 13, 2009
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High-yielding defensives are well worth looking at
Yesterday the FTSE 100 hit 5,300 at one point, its highest level since mid-September 2008.
That's fine if you're fully invested in the market. But it's not so good if you're now looking for a decent dividend yield for your money. The overall yield on UK shares has now dropped to around 3.5%.
So should you forget about stocks, and start looking elsewhere for income? Not at all - there are still some healthy yields around.
You just need to know where to look...
The case for the defensives
When share prices rise as rapidly as many have done recently, gains in the overall market are bound to outstrip any increase in the dividends that companies are paying out. And that in turn means that on average, yields on stocks must fall (yields decline as prices rise). As a result, investors looking for income are finding it increasingly difficult.
But if you're an income investor, there's no need to panic. There's a silver lining to the recent stock market surge. It's been driven by investors piling into low-yielding 'cyclicals' (the stocks that are most exposed to the state of the economy) in the hope of a sharp economic rebound. High-yielding defensive stocks have been largely left on the shelf.
As John Stepek repeated in yesterday's Money Morning (How you can survive the new bubble economy), we don't see this rally continuing. But you can still snap up some decent yields in top quality companies that the market has mainly ignored.
The good news about bubble conditions (for smart investors at least) is that the crowd buys into 'growth' stocks and ignores 'dull' businesses that make and sell real things – and pay real dividends. The dotcom bubble is a good example.
Investors piled into profitless and dividend-less tech stocks while everything was rosy. When that bubble burst in 2000, investors briefly learned to appreciate decent dividend payers again.
But since the market bottomed out around March 2003, high-yielding stocks have steadily fallen out favour. In fact, in terms of relative performance, high-yielding stocks are at an eight-year low compared to low-yielders.
UK high yield stocks are great value
In other words, high yielders now look cheap, both against the rest of the stock market and also compared with cash. Look at the chart below:
Bear with me – this is a tad technical, but it's worth getting to grips with.
The black line shows the yield on the FTSE Higher Yield index (which tracks companies with above-average dividend yields) divided by that of the FTSE All-Share index. As you can see from the left-hand scale, this has now climbed above 1.5 times. In other words, UK higher yielders are now paying out over 50% more than the average share. That's the highest ratio for almost nine years.
Meanwhile, the green line highlights the difference between the yield you can get on investing in UK higher-yield stocks, and the rate you can currently get for investing cash in the money market for three months. This is also near a nine-year high – high-yielding stocks will give you almost 5% per year more than cash.
In other words – and this is really remarkable – on both measures, for the first time this decade, UK high-yielding stocks look like a great place to park your cash.
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And fund managers are finally waking up to what's on offer. "Dividend yields on some blue chips" – shares in top-notch companies – "are better than some corporate bonds with the same name", says Paul Read of Invesco Perpetual. That's impressive because shares offer the potential for capital growth, whereas bonds by and large don't, so you'd normally expect the yield on shares to be lower.
Six blue chips to buy now
Jeremy Tigue at Foreign & Colonial agrees that several quality blue chips look good as "their dividend yield is attractive both in absolute and relative terms". Their share prices have "lagged the recent sharp recovery. And you can take comfort investing in global businesses that derive significant revenues outside of sterling".
So what are the best high-yield bets? Tigue likes tobacco group BAT (LSE: BATS), which at 1,999p is on a 4.9% current year yield, which is forecast to reach 5.3% in 2010. He's also keen on utilities National Grid (LSE: NG/) (628p), Scottish and Southern (LSE: SSE) (1068p) and telecoms giant Vodafone (LSE: VOD) (136p). All three are yielding more than 6% for the year to March 2010, and each is expected to hike its payout in the following year.
As regular Money Morning readers will know, we've been keen on these defensive stocks for a while, too. And there's another sector we like – big pharma. We spotlighted the healthcare sector recently (Snap up drug stocks while they're still cheap). It certainly still feels like the right place to find both good value and yield. In fact, even compared to other high-yielding stocks, drug makers are cheap. GlaxoSmithKline (LSE: GSK), at 1,259p a share, is yielding 4.8% for this year, which is forecast to rise to more than 5% next. And AstraZeneca (LSE: AZN), at 2,700p on a p/e of 7.5 and yield of 5.3%, looks like one of the cheapest stocks of all.
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