High yielding stocks are understandably attractive to investors during this era of low interest rates and stock market turmoil – when savings accounts and even bonds are no longer providing a decent income.
However, income investors should be wary of simply opting for the highest yielding stocks as this pay-out is often unsustainable. A stock’s yield can look artificially inflated by a recent drop in the share price, and as the share price returns to par, this yield will fall. Worse, if the share price drop is significant it could signal that the company is troubled and may well cut their dividend payment altogether.
Many mining and energy stocks fall into this scenario. The shares in these sectors have seen their prices have fallen for a while due to the slowdown demand in China, and continued fall in oil prices and commodity stocks. Level of risk within these companies also increases following the EU referendum, giving the uncertainty about the regulatory framework that they might operate with.
For this reason, we have identified income stocks below that are rated three-star by Morningstar analysts, meaning the stocks offer a ‘fair return’, one that should offer investors a return that's roughly comparable to the stock's cost of equity.
And among the 25 three-star rated stocks in Morningstar Select, three stocks display higher yields than their long-term average. One of them is an energy stock, but unlike many of their peers it recently pledged to increase its dividend for the year.
Sainsburys (SBRY)
Sainsburys is one of the largest grocery store operators in the United Kingdom, with around 600 supermarkets and 700 convenience stores. A vast majority of Sainsbury's revenue comes from the sale of food products, although the firm also sells gasoline and general merchandise in multiple channels. Convenience stores represent a little more than 5% of Sainsbury's total square footage, while traditional supermarkets represent the remainder.
The company’s solid online and convenience store presence should continue to fuel growth, Morningstar analyst Ken Perkins says.
The impact of acquiring Argos could help Sainsbury bolster its competitive position in an era of e-commerce, as Sainsbury will be uniquely positioned to sell general merchandise products in the online channel. However, this deal carries with it execution risk and the potential for management distraction, Perkins adds.
Sainsbury pays a dividend, and without a material margin cut related to price investments, Morningstar analysts expect the dividend to increase in line with earnings. The stock currently yields at 6.2%. In a normal competitive environment, analysts expect Sainsbury to repurchase 1%-2% of its shares annually.
Vodafone (VOD)
Vodafone is one of the largest wireless phone companies in the world. It is also one of the largest carriers in terms of the number of major countries served. It is a three-star rated stock by Morningstar analyst. The stock yields at 5%.
The company sold its stake in Verizon Wireless and distributed about 71% of the proceeds to shareholders, leaving it with a stronger balance sheet, Morningstar analyst Allan C. Nichols says. This enabled the firm to outspend its competitors in upgrading its network, while still increasing dividends and making acquisitions. The purchase of Kabel Deutschland (0MPU) and Ono, the largest cable television providers in Germany and Spain, respectively, are designed to help the firm grow again as well as reducing costs.
Despite the company’s project Spring slowed its dividend growth to 2.2%, Morningstar analysts do anticipate the company growth will increase starting in 2017, covering the dividend again.
SSE PLC (SSE)
SSE PLC is an energy holding company based in the UK. The company’s core business is its unregulated wholesale and retail segments, which together have historically accounted for about 60% of operating profits. The company’s regulated networks segment, which makes up electric and gas distribution and transmission services, provides more stable earnings. The firm is also involved in smaller related businesses such as gas storage, home energy services, contracting, and oil and gas production. The stock has a three-star rating by Morningstar analysts. It has a 5.9% yield.
Last week SSE pledged to increase its dividend for the year to the end of March despite guiding to lower adjusted earnings per share and warning on an uncertain market.
Profits from its retail business, which supplies electricity and gas to UK households and businesses, will be lower year-on-year whilst its wholesale division covering the production and storage of gas alongside electricity generation is expected to report broadly flat profits. SSE's supply business is also under greater risk from political outcry because of fuel poverty and resistance to price increases, says Morningstar analyst Andrew Bischof. The regulated operations are subject to regulatory risk, as the U.K. energy networks regulator effectively sets the level of profits.
"The operating environment remains challenging, due to factors including falling commodity prices and increased retail market competition, and the Competition & Markets Authority's provisional decision on remedies represents a substantial and in places challenging package," said SSE Finance Director Gregor Alexander.
