This is an extract from an article written by Michael Clarke who is the manager of Fidelity's money builder dividend fund.
For investors reinvesting dividends, an investment in equity income is best judged over a longer time period, over which the power of compounding has time to work. Unfortunately, investors have become very myopic in recent years and have great expectations for growth even over short time periods. Yet, there is much to commend in the opposite approach: invest in income-yielding shares and forget about the short fluctuations in stockmarkets for the next 15 years.
In my view, there has rarely been a better time to make an investment in equity income. Because of the general pessimism in stockmarkets, yields on equities are very high, well above their historical averages. Indeed, in Europe, current yields are significantly ahead of their 15-year average, moreso than they have ever been before. In the UK, valuations are also at one of the most attractive points for the last 10 years.
In fact, some equities are yielding more than their long-term corporate bonds.
For example, AstraZeneca is yielding around 5.7% versus only 4.8% on its long-term corporate debt. This is an unusual situation and normally happens when equities are very undervalued. In short, this is one of the best times to invest in the stockmarket that I have seen.
It's important to note I do not always buy the highest-yielding stocks in the market, however. My approach is to target companies that are capable of growing their dividends. I spend a great deal of time working out how sustainable a company's dividend is going to be, particularly in tough economic times like we have now. I then consider whether the company's dividend is covered by their cash-flow. This allows me to work out a forecast total return over the longer term. The underlying philosophy can be described as 'Safety of Income at a Reasonable Price'.
For example, Cable and Wireless worldwide offered a high dividend yield, but our analysis indicated its limited cash-flows meant that the company had negative dividend cover; a point of view that was vindicated when this company recently cut its dividend. At AstraZeneca, on the other hand, cash-flows are a multiple of dividends paid, providing over 2.5 times dividend cover, which is why this company is one of my favoured holdings.
So, it's a good time to invest - this is a great buying opportunity for patient investors. But, instead of taking a rollercoaster ride with the banks, I would rather invest in stable, dividend-growing companies like imperial tobacco, Glaxosmithkline and Vodafone, which all offer attractive dividend yields with good dividend cover.
