CNBC Business | Profit Scenter

Profit Scenter

Josephine Moulds tracks down the hot stocks to watch this month

With interest rates at record lows, income stocks are coming back into favour, and while these big, unfashionable companies may not enjoy the flashy growth of some of their peers, but they pay regular, chunky dividends – a blessing in these uncertain times.  

Dividends are not, of course, unassailable, but historically they have proved much more resilient than earnings. Last year dividends in Europe actually rose, while earnings declined. 

Companies in continental Europe have traditionally lagged behind their UK counterparts in the generosity of their dividends, but that appears to be changing. Last year, the Morgan Stanley Capital International (MSCI) European dividend  yield surpassed the MSCI UK dividend yield for the first time in five years.  

In December, European companies were yielding an average of 5.4%, compared with UK companies’ 5.1%. That looks incredibly attractive in a climate where German government bonds offer 3%, and European cash deposits are yielding less than 2%.  

Investors can choose a dedicated fund to enjoy the prevailing trend, such as Newton European Higher Income Fund, yielding 6.2%, or do the stock-picking themselves.  

When stock-picking, looking at the yield alone is not enough. Dividend yield is the annual dividend per share, divided by the share price. So, if a company is in trouble and its share price has crashed, the yield can look deceptively attractive. Investors must also consider the cash flow and earnings to determine whether the dividend is sustainable and has a modicum of growth.  

Telecoms are a classic income play, as they behave much more like utilities nowadays than the high growth stocks they once were.  

Deutsche Telekom is yielding 7%. More importantly, its cash-flow is 4.5 times what it is paying out in dividends, so it should be more than able to meet its commitments.  

The domestic market is tough with fierce price competition across the board. The only benefit of the credit crunch is that it should ease competition somewhat, as smaller players are forced into one another’s arms, and rivals undertake heavy cost-cutting.  

Deutsche Telekom (DT) itself has stuck to a strict cost-reduction programme, which should keep margins stable even as revenues in Europe decline.  

The company has a large mobile business in the US, which represents some 22% of earnings and should benefit from currency movements. As the dollar strengthens against the euro, DT will reap the benefits.  

The new management team has won the confidence of investors by flagging- up the slowdown in its domestic market, which should now end 2008 ahead of forecasts.  

They have also made a firm commitment that they will not ask shareholders for more capital to fund new acquisitions.  

As a result, investors can trust forecasts that 2009 earnings will be around the same as last year “or slightly higher”. Holding steady in this climate would be a triumph and growth is unnecessary for a dividend play.  

The company, which is listed on DAX, has an enterprise value (which includes debt) of around five times forecast earnings for 2009, in line with the sector average.  

Oil and gas, which, now that banks’ dividends are threatened, has become the highest yielding sector, is also worth a look.  

French group Total has a dividend yield of 5.8%, covered 3.7 times by cash-flow.  

Demand for oil has dropped because of the recession, and prices have fallen from a high of nearly $150 a barrel last year to less than $35 in January. However, Jeff Currie of Goldman Sachs expects the price to rebound in the second half and finish 2009 at around $65.  

Share prices have followed the oil price down, and there are now some bargains to be had among the oil companies, even disregarding the generous dividends they pay.  

Total is the fourth largest oil company in the world and is known for its exemplary execution. Put simply, it is good at finding oil, it produces it at a lower cost than its peers, and has a remarkably efficient refining and marketing network.  

The company’s assets are well spread across the globe, with oil and gas production from over 30 countries. It has a good balance of oil versus gas, and is one of the largest chemical producers globally.  

Overall, Total, which is listed on the Paris Bourse, is considered a safe-house investment among the oil companies. 

The shares are trading on around 9.5 times estimated earnings for 2009, compared with a sector average of more than 13 times.