Does RSA Insurance Group plc Pass My Triple Yield Test?

Like most private investors, I drip-feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.

However, the FTSE’s gains mean that the wider market is no longer cheap, and it’s getting harder to find shares that meet my criteria for affordability.

In this article, I’m going to run my investing eye over RSA Insurance Group (LSE: RSA) (NASDAQOTH: RSANY.US).

The triple yield test

Today’s low cash saving and government bond rates mean that high-yielding shares have become some of the most attractive income-bearing investments available.

To gauge the affordability of a share for my income portfolio, I like to look at three key yield figures — the dividend, earnings and free cash flow yields. I call this my triple yield test:

RSA Insurance Group Value
Current share price 100p
Dividend yield 6.2%
Earnings yield 10.4%
Free cash flow yield 0.7%
FTSE 100 average dividend yield 2.9%
FTSE 100 earnings yield 5.8%
Instant access cash savings rate 1.5%
UK 10yr govt bond yield 2.8%

A share’s earnings yield is simply the inverse of its P/E ratio, and makes it easier to compare a company’s earnings with its dividend yield.

RSA’s earnings yield of 10.4% looks attractive, but the firm has reported losses of around £140m from adverse weather events this year, and analysts have downgraded their consensus earnings estimates for 2013 to just 5.1p — which equates to an earnings yield of 5.1%.

It’s a similar story with RSA’s dividend. A cut is almost certain, as the company needs to preserve cash to bolster its capital position, after it was forced to inject £200m into its Irish business late last year.

Consensus forecasts currently suggest a 2013 total dividend of 3.4p, giving a potential yield of 3.4%, but RSA shareholders won’t know what the final dividend will be until the firm publishes its final results, on 27 February.

To buy, or not to buy?

I saw value in RSA shares at 90p, but the 10% rise since then has made me wary, as it has taken the firm’s share price above its net asset value per share of 99p.

I’m concerned that the investor exuberance that has pushed the share price up by 10% in three weeks could easily be reversed when shareholders are presented with a major dividend cut, for the second consecutive year.

In my view, RSA deserves a hold rating at present, as near-term risk is balanced by good long-term potential for overseas growth.

What's the real dividend risk?

Investing in high-yield shares is a popular way to generate an income that stays ahead of inflation, but it's important to understand how to recognise dividends like RSA's, that are likely to be cut.

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> Roland does not own shares in RSA Insurance Group.