By Stuart Rae and Katsuhiko Mano
Equity income has been a hot theme for Asian investors. But safer sectors that typically provide higher dividend yields are expensive. By casting a wider net, we think attractively priced income stocks can still be found in unexpected parts of the markets.
Dividend yield (DY) strategies have worked especially well in the Asia Pacific ex Japan region (Display). By providing a potent combination of safety and returns, these stocks have outperformed the broad market over time by capturing cash-generating businesses with good corporate governance in fast-growing markets. In contrast, high DY stocks in developed markets aren’t usually growth companies, so they usually produce lower returns than the broad market in exchange for the relative certainty of income.
After the global financial crisis, as investors sought safety, high DY stocks became extremely popular around the world and valuations generally soared. But since the Fed’s tapering talk began nearly a year ago, valuations of high DY stocks have retreated. In Asia Pacific ex Japan, the relative price/forward earnings of high DY stocks ranked in the top 20th percentile throughout its 10-year history last April. It’s now fallen below the bottom fifth percentile mark.
Defensive DY Stocks Look Expensive
So, does this mean that it’s a good time to buy traditional defensive stocks like consumer staples? Not really. We measured how valuations of high DY stocks in each industry compared with their own long-term average in relation to the broad universe. Today, relative valuations of high DY stocks in key defensive sectors such as healthcare, telecom and consumer staples, are near historical peaks (Display, left chart). At the same time, in some cyclical sectors — including real estate, retail and banks — high DY stocks are trading at a big discount to their long-term average.
Surprising Yields in Cyclical Stocks
Stocks from cyclical sectors are often overlooked in the hunt for DY. Investors tend to prefer companies with large dividends (high numerators), which usually come from more defensive sectors. Yet companies with low share prices (low denominators) can also qualify as high DY stocks — even if their absolute dividend payouts are somewhat lower. And if their share prices recover, you win twice.
In fact, cyclical stocks in Asia-Pac today offer dividend yields that are slightly higher than defensive stocks (Display above, right chart). This contrasts with conventional wisdom, by which high DY stocks typically are found in safer sectors with more certain cash flows, such as consumer staples and healthcare.
Designing a Smarter Strategy
This environment warrants a smarter DY strategy. In our view, investors should look beyond traditional income-generating sectors to build an equity income portfolio in Asia-Pac. Adding cyclical stocks to an Asia-Pac income strategy can create a portfolio with resilience through a volatile market cycle — which is becoming increasingly important today, in our view.
Careful stock selection is imperative. When choosing holdings, we recommend scrutinizing high DY stock from three angles: first, check if the company’s dividend is sustainable. Second, when buying defensive DY stocks, make sure that you aren’t overpaying. And finally, when buying cyclical stocks, verify that the company’s quality is solid because some high DY companies have low share prices for a good reason. Cyclical yield isn’t an oxymoron — in the current environment in Asian markets, it actually makes perfect sense.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio managers.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices, any securities or financial products. This article is not approved, reviewed or produced by MSCI.
Stuart Rae is Chief Investment Officer of Asia Value Equities and Asia ex Japan Equity Income, and Katsuhiko Mano is Senior Research Analyst, both at AllianceBernstein.