Risk when chasing high dividend yield

With the Australian share market now looking as if it will stay above the 5000 index level, now is a good time to reassess investment portfolios and strategies. If a review reveals weaknesses or uncertainty about individual investments, restructuring while the market is high will be less painful than doing so when the market is depressed.

The first step is to understand why individual share prices have risen so quickly. With the earnings reporting season coming to an end, it’s clear that the 20 percent rise in share prices is not due to a similar broadscale lift in company earnings.

The major impetus for the improvement has come from the fall in interest rates increasing the relative attractions of higher-yielding shares. The boost in demand has caused price increases on relatively low volumes as potential sellers are less attracted to alternative investments including term deposits.

A second factor in the rising market is the pressure placed on short sellers who during and after the GFC have profited from falling or weak share markets. With the prospect of a continuing support for shares as confidence returns and investors hunt yield, the hedge funds are being forced to look elsewhere for their profits.

While a sharp future fall in the market cannot be ruled out, the fact that the dividend yields are still well above fixed interest returns will continue to generate demand for quality shares. But until earnings per share start to rise, there’s reason to be concerned about the rising price to earnings ratios of all our leading share companies.

For example, while Telstra’s earnings have increased by less than 10per cent, the share price has increased by 50 percent or even more from GFC levels. The dividend yield is, however, still around 6 percent p.a. fully franked down from 8 percent p.a. not long ago.

Asset Check’s assessment of likely movements in our share price assumes that this week’s uncertain Italian election outcome won’t result in a collapse of the Eurozone. While the next few months may be a difficult period for the Eurozone, fortunately for the Australian economy, our most important trade links are with Asia and the US, not Europe.

Nevertheless, the continuing problems in Europe make it essential for share investors to be prepared for volatility. Purchasing Australian shares at current prices if the only objective is to obtain a higher dividend yield definitely involves risk.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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