Dividends have historically played a substantial role in total investment returns. The humble cash payout has served long-term investors well, whether ASX shares or global companies, over many decades.
The S&P/ASX 200 Index (ASX: XJO) currently yields 4.5%. A respectable income in its own right. Although, now might be an opportunistic time to locate even higher-yielding stocks and lock those returns in for the long haul.
Temporary fear
Usually, stock pickers need a healthy dose of scepticism when uncovering companies offering yields in the high single digits or higher.
By all means, maintain a desire to dig deeper when reviewing investment options. However, the difference at the moment is a broad sense of gloomy times ahead. As a result, numerous high-quality businesses have potentially been lumped in with the laggards.
An enormous amount of pessimism hangs in the air as headlines preach the high likelihood of recession gripping Australia in the next six to 12 months. What those same articles don't normally discuss is how recessions come… and go.
Many ASX shares have stood the test of time, surviving through economic troughs and thriving on the other side. Despite this, all too often, people will forgo the chance to add to their portfolio while in the eye of the storm.
One solid indication that we've already stepped into the arena of fear is the 12-year low in the Aussie benchmark's price-to-earnings (P/E) ratio.
Don't get busted
The caveat to all this is taking steps to avoid the yield traps. A good pulse check for dividend sustainability is the dividend coverage ratio (DCR), essentially the inverse of the more commonly known payout ratio.
Generally, a DCR greater than two puts an ASX share's dividends in the 'healthy' range. This would indicate the company can cover its dividends payout twice over from its earnings. There are always exceptions to the rule, though this is a decent rule of thumb.
Another factor to watch out for is one-off events. For example, if a portion of the company is sold off, that cash can be returned to shareholders as a special dividend. The non-recurring nature of the income means it is unlikely the dividend will be as juicy in future.
Where to look among ASX shares?
There's a whole host of companies on the Australian share market advertising yields above 5% — a grand total of 289, in fact. That's a lot of options to pick from, but it's crucial to identify those high-quality names from the bunch.
The likes of BHP Group Ltd (ASX: BHP), Rio Tinto Ltd (ASX: RIO), and Woodside Energy Group Ltd (ASX: WDS) could look appealing. These beasts of the index are profit machines. But, the cyclic nature of commodities threatens the longevity of their high yields.
Instead, two ASX shares that catch my eye are Deterra Royalties Ltd (ASX: DRR) and Premier Investments Limited (ASX: PMV) — yielding 7.7% and 5.5%, respectively.
Deterra is also exposed to commodities. However, its low operating costs could provide more wiggle room during the down cycle.
Meanwhile, Premier Investments is a retailer that's been operating since 1987. Arguably, it could take a hit during a recession. What gives me confidence in Premier Investments is its considerable net cash balance and a reasonable DCR of 1.72 times.
