All this week we bring you the best income opportunities across the globe, as picked by top fund managers, professional investors and our own stock and fund analysts as part of Morningstar’s Guide to Finding Investment Income.
The US stock market reached a new record-high this week with the S&P 500’s market value hitting $20 trillion on Monday. Rising consumer confidence levels mixed with forecast tax cuts led many stocks to trade higher and boosted various sectors over the past three months, said Dave Sekera, managing director of corporate credit ratings with Morningstar.
US stocks are trading at a 60-year valuation high versus other global benchmarks, according to Hermes Investment Management. The S&P 500 trades on a cyclically-adjusted price to earnings ratio of 26.1x, versus a STOXX 600 European index which is on 16x.
“Almost every equity market in the world is trading at a substantial discount to US large cap stocks. While we tend not to make top-down market calls, it is hard to envisage a scenario where the US market can continue to extend its gains before the rest of the world begins to catch up,” said Tim Crockford, European equities portfolio manager at Hermes.
While US stocks are trading above values, data from Morningstar Select showed that they are currently paying attractive yields. There are 29 stocks yield above 5% in the US, of which five are yielding at double digits, however the sustainability of these dividends are questionable.
Take Frontier Communications Corp (FTR) and Waddell & Reed Financial (WDR), two of the highest dividend paying stocks on the list as examples. Frontier currently yields at 12.8% however Morningstar equity analysts suspects the firm will have difficulty maintaining its capital structure and dividend coming forward. Waddell & Reed currently yields at 9.9% however Morningstar equity analysts believe that the dividend is ripe for a cut if the company is looking for cash to reinvest in the business.
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.
For this reason, below we have identified three income stocks that are rated three-star by Morningstar analysts, meaning they consider the stocks to be fairly valued.
Guess? (GES)
Guess currently yields at 6.7%. The company designs, markets, distributes, and licenses contemporary apparel and accessories that reflect European fashion sensibilities under brands including Guess, Marciano, and G by Guess. Bridget Weishaar, Morningstar’s equity analyst believes there will be enough cash for the company to continue the dividend programme while the firm continues to invest in fund capital projects.
Guess has an almost debt-free balance sheet, generates solid free cash flows, and pursues investor-friendly activities, said Weishaar. She added that the dividend payout ratio was north of 90% in fiscal 2016.
In the next five years, analysts think revenue will grow an average of 3%, below their prior 4% estimate, as the store base is expected to grow 50% over the next three years but weakness in the Americas and select Asian markets persists. However pockets of improvement have appeared, including Europe retail sales, Weishaar added.
HCP (HCP)
HCP is a real estate investment trust that yields at 6.1%. It has interests in over 400 senior housing facilities, 100 life science properties, 200 medical office buildings, 15 hospitals, and other healthcare properties, said Edward Mui, Morningstar’s equity analyst.
Over the years, HCP has benefited from industry tailwinds that have allowed this “Big Three” healthcare REIT to achieve 31 years of consecutive dividend per share increases, said Mui.
As a real estate investment trust, HCP is required to pay out 90% of its income as dividends to shareholders, which limits the company’s ability to retain its cash flow, said Mui. However, he expects the company’s overall credit to remain healthy through steady rental income growth in its existing portfolio in the near term, funding requirements for its debt maturities and development activity through a combination of new equity issuance, debt issuance, and asset dispositions.
Greenhill & Co (GHL)
Greenhill & Co currently yields at 6%. The company is an independent investment bank that derives the majority of its income from financial advisory. Historically, Greenhill has derived about 40% of its revenue outside North America, said Michael Wong, equity analyst with Morningstar. Wong said the company should be able to maintain its dividend, especially if it holds back on repurchasing shares.
On a cash basis after accounting for the company's equity compensation, the company should have cash flow from operations around 50% higher than the dividend, said Wong. The company’s business model generates high free cash flows, and the company could always postpone the share repurchases it uses to manage its equity base, Wong added. Therefore, he views the company as having decent financial health.
Independent financial advisory firms have been gaining market share of merger and acquisition volume, so the firm may be able to grow faster than the M&A industry as a whole. A relatively high exposure to Europe could prove beneficial to the firm if the geography strengthens its economic recovery, Wong added.
