It has been a turbulent few days in global stock markets – and there may well be more of that to come. Ups and downs are part of being an investor. But I think the current stock market volatility could present me with some interesting opportunities. Income stocks I already liked increasingly look like high-yield bargains for my portfolio.
Volatility and yield
A lot of investors get nervous about market volatility. But one of the potentially positive things about it is what it means for yield.
Imagine that a share trades for £1 and pays an annual dividend of 5p. We say that it has a dividend yield of 5%. But if the share price falls to 80p and the dividend is unchanged, the yield has gone up – it is now 6.3%.
So if I put £1,000 in at that share price, hopefully I would receive around £63 of dividends annually, compared to £50 per year if I had bought when the same shares traded at £1 each.
But there is a caveat. Dividends are never guaranteed. It may be that a share has fallen from £1 to 80p because of a broad market panic, when the company’s commercial prospects and dividend outlook are unchanged.
However, the share price may have fallen because investors believe that the company’s outlook is worse than before. That could end up leading to a dividend cut.
High-yield bargain hunting
So how can I tell whether a tumbling share price might be presenting me with a high-yield bargain or a value trap?
My approach is to consider the long-term business prospects of a company and whether recent events may have affected them.
For now, I am unclear whether or not the current banking crisis may hurt profitability at UK banks and so I am not buying into them. But there are some high-yield shares I think are unlikely to be affected.
For example, British American Tobacco and rival Imperial Brands yield 7.3% and 7.4% respectively. Both face risks that could endanger their dividends in future, such as debt and declining cigarette usage. Indeed, Imperial cut its dividend three years ago. But I do not expect a banking crisis would greatly affect either firm’s profitability.
Similarly, miners such as 10.5%-yielder Glencore and oil companies including 7.6%-yielding Harbour Energy also look unlikely to me to see profit prospects fall dramatically due to a banking crisis.
However, although volatile markets may be pushing up the yield on shares, in itself that does not make them attractive to me. I continue to look for high-quality companies trading at attractive share prices. A high yield on its own tells me nothing about whether a company has strong future prospects, or how attractive its share price might be.
Long-term outlook
I think the current market volatility is throwing up some high-yield bargains. But it is important for me to assess what I am buying carefully. I buy with the intention of holding shares for the long term.
So if a share price has fallen, I do what I always do. Assess a company’s long-term outlook and what that might mean for its future dividends.
Sometimes a seeming bargain in fact turns out to be a value trap. Spotting the difference in advance could improve my investment returns a lot!
