With interest rates falling to just 2% this year, it is understandable that Aussie investors are seeking out top notch income stocks. After all, the returns on cash balances barely cover inflation and, with the RBA seemingly likely to move rates further down, there is a danger that cash may yield a negative return when the effects of inflation have been taken into account.
However, another danger facing investors at the present time is buying shares in what appear to be great dividend stocks, but that turn out to be anything but. For example, a company may have a high yield, but its dividends may not be covered by profit, thereby leading to a dividend cut down the line. Similarly, a company may have a relatively high yield, but its earnings growth may disappoint and force dividends to either only be maintained or cut. And, if dividend stocks are too expensive then the income returns could be more than offset by capital losses over the medium term.
On the face of it, telecoms company, Telstra Corporation Ltd (ASX: TLS), appears to be a superb dividend stock. It yields a fully franked 5% and, looking ahead, is forecast to increase dividends per share by more than twice the rate of inflation, with them set to rise by 3.2% per annum over the next two years. And, with Telstra diversifying into areas such as e-healthcare and also generating a rising proportion of sales from faster growth markets across Asia, it seems to be a great income stock for the long term.
However, Telstra has a rather disappointing track record when it comes to dividend growth. For example, over the last 10 years it has reduced dividends at an annualised rate of 1.2%. Clearly, this is disappointing and, in addition, Telstra's dividends were covered just 1.1 times by profit in its most recent set of full-year results, thereby providing minimal headroom.
Investors, though, should not be too concerned with these figures. That's because, as mentioned, Telstra has bright growth prospects and, in the next two years for example, is expected to increase its net profit at an annualised rate of 8.1%. And, with dividends due to be covered 1.25 times by profit in financial year 2017, the current yield and growth rate in shareholder payouts appears to be sustainable.
Similarly, packaging company, Amcor Limited (ASX: AMC), may cause investors to be slightly concerned regarding its income prospects. That's at least partly because Amcor yields just 3.6%, which is considerably less than the ASX's yield of 4.6%. And, with Amcor's earnings set to fall by over 9% in financial year 2015, its profitability seems to be coming under a degree of pressure, which may not indicate strong dividend growth.
Despite this, Amcor has huge future potential. For starters, it has a relatively low payout ratio of 55% and, as a result, it is forecast to increase dividends at an annualised rate of 12.8% during the next two years. This means that Amcor has a forward yield of 4.2% and, with its earnings due to resume their rise in the current financial year with growth of 3.2% being pencilled in, its future prospects appear to be relatively bright. That's especially the case since it is increasing its exposure to the fast-growing emerging world which, in the long run, should deliver impressive top and bottom line growth and enable Amcor to boost dividend payments.
