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Like many investors, I appreciate the potential income I can get from holding high quality stocks. So, from time to time, I think about what are the best stocks to buy for their earning power.
To that end, here is one UK stock that I think money-focused investors should consider.
Almost a double-digit return yield
The assignment in question is Henderson Far East Income (LSE: HFEL).
At first glance, some of the attractions are obvious.
This investment trust manager says “looks to expand the growing opportunities for income investing“, especially in the Asia-Pacific market. It has a progressive dividend policy, which means that it intends to increase the dividend per share annually – as it has been doing in recent years.
It pays dividends quarterly. That can be helpful in terms of providing a regular income stream.
I like the fact that these are paid like clockwork, however no dividend payout is ever guaranteed to last.
Until recently, Henderson Far East Income had a double-digit percentage yield. But with the stock up 27% since April, the yield has fallen.
Still, at 9.8%, it remains firmly in the high yield category!
Disappointing share price performance
But if you want stocks to be, a water yield can be a red flag. Could that be the case here?
First, Henderson Far East Income sells for the value of its entire assets. It may be more attractive if it is sold at a discount, but on the other hand the mere fact of the premium can be well interpreted as a sign of investor demand for the share.
Although the share has performed well since April, the long-term picture has not been attractive. In five years, the price has dropped by 24%.
In part that reflects economic uncertainty in other key Asian markets. But I think it also points to the concern of some investors about how sustainable the dividend can be.
This is always an important question to examine when looking at investment trusts with income as the objective. Are they getting large returns on their portfolios, or are they using stock sales or other means to help fund dividends, thereby consuming more capital or increasing the cost of dividends?
The second method can sometimes work but usually has a long-term cost as the payments can become difficult to maintain, let alone increase.
Can this level of profit be sustained?
Last year, Henderson Far East Income spent £43m paying dividends.
That’s a smidgen more than £42m of net income from operating activities. The trust did not provide a breakdown of what comes from the profits received versus the profit from selling the shares it owns.
Even so, however, that meant that dividend payments swallowed up the entire operating cash flow. The trust can and does raise money from passive activities, such as bank loans and selling shares.
Therefore, the dividend can continue to grow every year in line with the target. But I see a risk that it won’t, given how much the dividend is worth relative to operating cash flow.
But Henderson Far East Income has a diversified portfolio that provides exposure to a region with continued strong growth opportunities. I see it as a share for income investors to consider.
