What are we looking for?
Citigroup’s global equity strategy team has come to the same conclusion most market watchers have: “Investors are starved for yield.”
So, it went hunting for it, in equity markets around the world.
And, it found, various regions present different challenges in this quest. Europe might be the most challenging right now – because high yields in many cases may be a function of high risk, in the form of exposure to potentially perilous sovereign debt.
“In Europe, high dividend yields on offer may not be as certain as in other regions,” Citigroup wrote in a recent research report. That’s because over-exposure to a debt crisis – as we saw with many U.S. companies in the 2008 credit crisis – can be a fast track to a dividend cut.
So Citigroup’s European strategists, Jonathan Stubbs and Adrian Cattley, measured companies’ dividend yields against their credit default swap (CDS) spreads – to reveal which European stocks offer the best risk-adjusted yields.
Adjusting for EU debt risks
The strategists devised a stock screen that, first, eliminated the higher-risk dividend payers by screening out anyone with a CDS spread of more than 120 basis points.
Then they took the dividend yield over the past 12 months and divided it by the company’s CDS spread – thereby adjusting it for the implied risk to the company’s debt position. (For example, a company with a dividend yield of 5 per cent and a CDS spread of 120 basis points (in other words, 1.2 per cent), has a CDS-adjusted yield of 4.2 per cent.) They included only those stocks with a CDS-adjusted yield of more than 4 per cent.
They set a market capitalization minimum of €10-billion ($13.1-billion), and considered only stocks with buy or hold recommendations from Citigroup’s equity analysts.
What we found
The Citigroup strategists came up with a list of large-capitalization European stocks meeting all the criteria that have the highest dividend yields; we’ve reproduced the top 20 here. At the top of the list was Zurich Financial Services, a Swiss insurance company, with a yield of 7.7 per cent.
The strategists noted that debt leverage, especially outside of the financial sector, has come down significantly among European stocks, leaving them looking less risky than many European sovereign issues. Yet average dividend yields for the low-CDS stocks in this screen are considerably higher than the sovereigns – making them relatively attractive.
However, they warned, “companies with high CDS should not be considered in an income strategy. The risk of a dividend cut is too great.”