Top Income and Dividend Stocks

High yield cash savings accounts in Australia (like ING Direct, Bank West) are currently providing an 8% or so pre-tax return. Not bad when you consider that the stock market is down more than 20% this year. Why would you even think about investing in the stock market, when getting an 8% return is so easy and risk free? Well, because the after tax returns of stocks are going to be much higher than the cash savings account over the medium to long term. A stock provides two sources of return – capital growth and more importantly in this climate, dividend income. I agree that the capital growth aspect is pretty lousy at the moment, but there are some solid dividend paying stocks to look for that pay a better than 8% return over the next couple of years. Also, if you include franking credits from dividend payments, the dividend income can be substantially higher when compared to the equivalent after tax return from high yield savings account. An 8% pre-tax return on a high yield cash account is equivalent to 5% to 6% on an after tax basis. Whereas, an 8% return on a 100% fully franked dividend is equal to an after tax return of between 12% to 15%, depending on your tax rate. Which do you think is better now?

So what are these dividend stocks that pay more than 8%? Well, from Aegis Equity Research, here is a list of the highest paying fully franked and unfranked/partially franked dividend paying stocks. Franked or partially franked dividends provide franking credits (i.e. the tax the company has already paid) which you can use to offset your regular income provided you are an Australian resident. Unfranked dividends don’t have those franking credits. This could be for reasons that include, but not limited to, the company earnings are overseas or they did not pay taxes (due to how they account for their profits). Also for non-residents, like me, these can be better investments as I cannot access the franking credits and they tend to offer higher yields to offset the franking credit tax benefits.

From the list (click on list to enlarge), you can see plenty of stocks from the Macquarie Group(MQG) and Babcock and Brown (BNB) stable of investment vehicles. They have created these "stocks" to invest in a particular types of industry or assets. For example, Babcock and Brown wind partners (BBW) invests in wind energy generation assets and Macquarie Airport (MAP) invests in airports. These type of stocks tend to have a stable cash flow and thanks to legal accounting loopholes they are able to provide good tax-deferred returns. Due to the fact they are highly leveraged, they have taken a big hit to their prices from the credit crisis and their dividend yields have gone up because the actual dividend amounts have not beet cut. Macquarie and BNB managed investment vehicles are pretty well capitalized and have the implicit backing of their parent companies, so their share prices should eventually recover, which means current prices provide good entry points.

Overall, the stocks I like from the above lists are:

Suncorp Metway (SUN), Commonwealth bank (CBA) because these two financial companies are among the best of breed in their financial sectors. Apart from dividend growth they have got strong potential for capital growth in the medium term. I like Tabcorp (TAH) and Telstra (TLS) for their defensive nature and should hold up when the times get tough. For the unfranked or partially franked top stocks, I like Babcock and Brown Power (BBP), SP Ausnet (SPN), Ascianco Group (AIO), Macquarie Communication Group (MCG) and Babcock and Brown wind partners (BBW). I would stay away from the retail and consumer stocks like Pacific Brands (PBG) and Wattyl (WYL) because I think consumer spending will fall significantly when the economy starts heading south. Look my upcoming post “Is Australia entering a recession?” for more on my views on the tough times I think are in store.

Most of the companies in the above lists attract investors through their higher than average dividend yields. So they will be reluctant to cut dividends in fear of losing investor support and will instead focus on cost cutting measures to keep payouts at current levels.

Eventually, the share market will bottom out and begin its climb up. The appreciating share prices will then boost your capital gains, which combined with the current dividend yields make share investing a much more profitable (especially when you factor in tax) venture over the medium to long term than leaving your money in cash accounts.

Related Posts:

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