3 stocks for incoming-seeking investors

Companies paying bigger than usual dividends offer advantages over pure-income stocks.

Andrew Mudie

Andrew joined the growing team of Motley Fool freelance writers in mid-2013 following years of personal development as a passionate self-taught sharemarket investor. At the time, Andrew was an engineer by trade, writer by hobby, and an investing nerd by passion who spent far too many breaks reading, writing and learning. Andrew’s first investing lesson came with his first stock selection in 2011 when takeover rumours caused a spike and subsequent plunge in the share price of Woodside and then the 21% fall in the market through mid-2011. The next four years of investing saw Andrew dabble in a vast array of strategies until settling on his favourite investment methodology, which is closely aligned with that of the Motley Fool: Fundamentals-based long-term buy-and-hold of great companies at great prices.

Published January 13, 2014 4:50 am AEDT

The strong performance of income stocks in 2013 has left investors all over Australia asking: 'Where to from here?'

Some questions continue to beg for answers:

Should investors sitting on 40% plus returns from the big banks be looking to sell down their stake?
Are growth stocks now the place to be?
Where are the best places for my money?

Unfortunately there are no easy answers. However, for investors interested purely in dividend income, holding onto companies such as National Australia Bank Ltd. (ASX: NAB) which have risen over 30% in a year remains an obvious choice as there is little doubt that the dividend payout will increase in the years ahead. Additionally, depending on your purchase price, the big four banks could be yielding in excess of 8% now.

But for investors ready to start buying income stocks now, the answers are less clear. Income stocks are expected to underperform once interest rates rise with an improving economy, and their incredible share price performance over the past 18 months has made picking individual companies difficult.

Therefore, in my opinion, investors should be looking for companies with above-average dividend yields that are also leveraged to an improving Australian and world economy. Here are three options:

Insurance Australia Group Limited (ASX: IAG) is forecast to deliver a dividend yield of between 5% and 6% for the next two years. The group will benefit from the acquisition of Wesfarmers' Australian underwriting business and general growth in the Australian insurance market. Its not traditionally a big dividend paying stock, but with few natural disasters of late, the group's cash flow will continue to fund solid dividends.

Woodside Petroleum Limited (ASX: WPL) has cut capital expenditure at its many liquefied natural gas deposits as a result of the high cost of labour in Australia. The return on equity of Australian projects is so poor that the company has instead opted to deliver a larger proportion of earnings to investors through dividends. A yield of between 5% and 6% is expected for the next few years.

Finally, retailer Myer Holdings Ltd (ASX: MYR) represents one of the best companies in the bricks-and-mortar retail sector. Myer also has one of the best online stores, and unlike some of its rivals operates online fulfilment centres (warehouses) that exist solely to quickly distribute the company's 15,000 best-selling online items. This eliminates double handling by local stores and improves the overall efficiency of the company. As a result, Myer's online sales are due to hit $50 million and become profitable in 2014. The company is currently returning a yield of around 6.5%.

Foolish takeaway

Dividend stocks had a great run in 2013 and 2014 could be another good year. In this investor's opinion, income seekers should consider companies with exposure to an improving Australian economy that currently pay above-average dividends but are not known exclusively for it. This strategy should mean that investors are protected from significant capital losses if pure income stocks fall out of favour in the future.

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