One of the most attractive features for investors is the potential for high yields. Let’s face it, the financial crisis — or more to the point, the global actions taken to put the world back on track — has caused no end of pain for those who relied on the income from their savings in order to support them and their family in retirement.
The painful result of the current low interest rate environment has left savers wondering where to turn for that precious income. Those who turned to the FTSE 100 and held their nerve through the ups and downs over the last few years have benefited from an increased capital base and a steadily rising income, above that of inflation.
But for those who sat on the sidelines, is there currently an opportunity in the battered mining sector?
Beware Unusually High Yields
The median forecast of all dividend-paying stocks according to Stockopedia is 2.99%. Now, it is not unusual to see dividends of half (or, indeed, double) this amount: one only needs to look at ARM Holdings, currently forecast to yield just 0.96%, and insurer Admiral, forecast to yield 6%.
But when the forecast yield begins to rise towards the 7%+ mark, as is the case with BHP Billiton (LSE: BLT), Anglo American (LSE: AAL) and Hargreaves Services (LSE: HSP), I start to wonder whether this is simply what is known as a dividend trap – and, as such, a closer look is required before investing.
Invest At Your Own Risk!
I’ve been following events over in China with interest, including the effects that they seem to have had on the price of raw materials and the UK-listed resource stocks responsible for producing them. A quick glance at the chart below illustrates the impact on earnings of these stocks and the price of the shares.
On the subject of price, you would need to go back as far as the financial crisis to pick shares in these businesses up at a similar price – so what’s stopping me from piling in?
Further Downgrades To Come?
The main factor behind my thinking here is the fact that brokers have been downgrading their earnings expectations for all three of these stocks.
In the case of BHP Billiton, earnings per share for the year ending 30 June 2015 are expected to come in at $1.40, and $0.93 for 2016. With the company looking to pay a full-year dividend of $1.27 in each of these years, we see the dividend cover fall from over 2 times earnings in 2014 to just over one times covered this year and not fully covered in 2016 – this is a red flag for me.
We see a similar pattern with Anglo American, although going in the opposite direction – here, the dividend wasn’t covered by earnings in 2014, whilst analysts expect it to be covered 1.13 times in 2015, rising to 1.35 times in 2016.
Hargreaves Services, whilst still adversely affected by lower coke and coal prices, has been more sensible with its dividend cover in my view. I think we are seeing the company managing the decline in its business quite well. Indeed, the price of the shares has fallen so much that the shares are forecast to yield over 9% — so why won’t I invest? Well, turning to the year-end update, I saw nothing but bad news:
- Continued lower price pressure in core markets;
- A number of coal-fired power stations announcing closures;
- The company accepting a lower amount on a recent biomass conversion project.
The list went on… Even with management action, I wouldn’t be surprised to see the shares fall further from here.
The Foolish Bottom Line
Whilst I can see the attraction of the unusually high yields on offer here — coupled with the potential of industry consolidation going forward — for me and my capital, it’s just too risky!
For those of us searching for yield, one of the best tried and tested methods is to adopt an approach towards a more diversified portfolio, tailored towards good solid income producing stocks - the sort that will make money whatever the weather.
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Dave Sullivan has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.