Be Wary of High-Yielding Stocks

VIDEO: It's imperative to actively pick your high-yielding stocks, as a high yield is often a sign of a poor company, says Newton's Nick Clay

Holly Cook 22 May, 2013 | 2:28PM
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See full coverage of the Morningstar Investment Conference here.

Holly Cook: Investing for income was a clear theme at the recent Morningstar Investment Conference, and I caught up with Nick Clay of Newton Investment Management, and asked him from a global perspective where does he see the best opportunity for income seekers. Here is what he had to say. 

Nick Clay: Interesting question, because if you had asked me that question, say, five years ago, I would have said there was a definite bias to finding the best stocks in Asia and emerging. That was because in those days there wasn’t this risk that came with sovereigns, i.e. the debt hadn’t built up to the government level. Now, that has been built up pretty much across the board now. There is a lot more risk at the country level and less risk at the company level. So now it’s more about the companies you find rather than a geographic bias within your portfolio. We are finding ideas in America. We are finding ideas in Northern Europe. We are finding some ideas, but not many, in Asia and emerging; we’re preferring to play that through western companies with exposure to that area rather than directly. But it is really about the companies today and not really about the particular geographies any more. 

Cook: And here in the UK, it sounds like as a UK investor you are – actually you’ve got potentially more of a kind of stable outlook when you’re looking at dividend payers compared to perhaps the US where it might be little bit more volatile? 

Clay: Yes. I mean, it's about the alignment of the interest of the company with you as an investor. If they are committed to paying that dividend, it can be very stable, and if you get the right company, growing stream of your total returns. I’ve been a fund manager 20-odd years now, a company has never asked for a dividend back. So at the worst the dividend is ever going to be zero and that lends a degree of consistency, and in a volatile environment of returns, that consistency ends up being quite a powerful driver of returns. 

Cook: We have seen investors trying to get sort of more and more creative in terms of finding that income, and so a bit of a shift sometimes towards the high-yield dividend payers. How do you find those high-yield dividend payers and kind of what process do you need to use? 

Clay: That's really important, because being active in this current environment is what so key, because we’re all being forced to take on risk to generate the return. You put your money in the bank in cash, you get a negative real return; you lose money. So to generate a return you have to assume some kind of risk, and the problem with investing in high yielding equities is they yield a lot for a reason. Generally, they are bad, they are rubbish companies; they are distressed in some way, there is something wrong with the cash flows, the dividends are unlikely to be pay out and will be cut. 

You can't just passively or from an index perspective invest in this area, you have to choose the right companies, and the right companies are those which have stable returns, good cash flow dynamics, and therefore can continue to pay that dividend and have a management who allocate the capital within that company in a very good and appropriate way for you as an investor, because it will fund the cash with growing dividends or fund the company to protect the returns or (won’t) destroy that capital going forward in that front to mine those dividends. 

Cook: Well, Nick Clay, thank you very much for those useful tips. 

Clay: Thanks very much. 

Cook: Thanks.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Holly Cook

Holly Cook  is Manager, Morningstar EMEA Websites

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