In a year where many investors are expecting a return in their dividends, are we running the risk of overvaluing stocks just because they’re paying out some of their profits?
That could be the case for the Australian Foundation Investment Company Ltd [ASX:AFI], which last week announced its interim dividend will remain the same despite a significant hit to revenue and profit during the first half of FY2021.
It has been a steady march upwards for the AFI share price after the crash in March last year, with the investment firm turning a positive 12-month return in November.
Are companies desperate to keep their yields high?
Investors have been told by many mainstream media organisations to expect a ‘dividend downpour’ this year after payout levels were obliterated due to COVID-19-induced lockdowns.
But are these expectations realistic?
Perhaps, for large institutions like Australia’s banks, a return to regular dividends is more likely to be on the cards than for other stocks.
Although, if the expectation is that dividends across the board are going to return, what are we to expect regarding the share price performances of dividend-paying stocks?
Will people buy in the hope of getting a juicy payout, consequently inflating the share price?
That could be the case with AFI.
Last week, the company announced it will keep this year’s interim dividend payout the same as its previous interim dividend — at 10 cents per share, fully franked.
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However, its financial performance for the first half of FY2021 left a lot to be desired.
Revenue from operating activities was $96.2 million, down 38.9% from the previous corresponding period.
Meanwhile, profit after tax was $84.1 million, down 42.4%.
Interestingly, the results had little impact on the share price at the time they were announced.
Consider dividends in a broader context
AFI currently has a dividend yield of 3.19% and a price-to-earnings ratio of 37.9.
So, some might argue the stock is overvalued because of its payout levels.
There might be some truth to this.
If we compare it to some of the traditional dividend stocks (the banks), it doesn’t stack up to the likes of Commonwealth Bank of Australia [ASX:CBA], which has a dividend yield of 3.50% and a PE ratio of 15.6.
However, it could be a better pick than Westpac Banking Corporation [ASX:WBC], which has a yield of just 1.42% and a PE ratio of 34.2.
The takeaway here is: With investors chasing dividends this year, there is a risk that high-paying stocks could become significantly overvalued.
If you’re on the hunt for some of Australia next top income stocks, be sure to check out our free dividend report. In it, we reveal our top five ASX-listed dividend stocks with a great chance of maintaining big payouts in the post-pandemic era. Click here to download your free report.
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