Yields now main game for investors

At the start of June we touched on the increasing appeal of Australian equities as 'yield plays' in an investment environment of constrained capital growth, increased volatility and lower interest rates.

This trend has continued if not accelerated over the past few weeks as the August/September reporting and dividend season nears.

Further supporting this trend has been an out of favour resources sector, under pressure from slowing global economic growth and weaker commodity prices.

The accompanying table shows the year to date performance of Australia's 20 leading stocks together with their forecast financial year 2012 dividend yield and franking.

It is clear that the higher yielding banks, major food retailers and Telstra have significantly outperformed generally lower yielding, resources exposed companies.

With such a divergence in performance, investors now need to decide whether the flight to yield has pushed some of these stocks to unsustainable levels.

Before making this judgment it is useful to remember the golden rule of investing in high-yielding stocks - high yield is good as long as it can be sustained. This means most investors would prefer a sustainable 5 per cent dividend yield than an unsustainable 7 per cent. This is particularly true when you consider what usually happens to a company's share price after it has downgraded earnings or dividend guidance. So how do Australia's top yielding stocks shape up?

Big 4 Banks (WBC, ANZ, NAB, CBA)

Our major banks face a challenging medium term outlook amid low credit growth, margin and funding pressures and their high level of exposure to Australia's housing market.

Given these downside risks and that fact that dividends currently represent 70 to 80 per cent of earnings we maintain a cautious view on the sector.

Major food retailers (WOW, WES)

The recent quarterly reports show the strength of our major food retailers despite difficult trading conditions across the Australian retail space.

WOW was one of the few companies that increased its dividend during the GFC. WOW's forecast dividend payout ratio of 71 per cent appears more comfortable than WES's 88 per cent.

Telstra Corp (TLS)

TLS has re-affirmed its intention to pay dividends totalling 28cps in FY12 and FY13 (7 per cent yield at $4.00/sh). We continue to like TLS but note the recent share price gains have moved it out of 'compellingly cheap' territory. We expect TLS will become more of a yield story and less of a capital growth story from here on.

While watching investor's reactions to a profit result is interesting, the intriguing part will be observing what level of underlying (long term) investor support they have after they go ex-dividend.

Information contained in this article does not consider your personal circumstances. You should consult a stockbroking professional before making any investment decisions. Sentinel may hold positions in stocks discussed from time to time.