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4 Reasons to Buy High Dividend Yield Equities in Europe

As bond yields go negative, dividend yields shine. 
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European purchasing managers' surveys are confirming that the eurozone's recovery continues in the last quarter of the year, pushed ahead by the European Central Bank's quantitative easing.

The eurozone composite PMI came in at 53.9 in October, a figure which economic analysis think tank Capital Economics says is consistent with quarterly GDP growth of around 0.4%. But looking at producer prices, there are no inflationary pressures ahead; in fact, the output prices index was revised downwards to 49.6, below the "no change" mark of 50 for the first time in three months.

This means the ECB will be in no hurry to reduce its stimulus. On the contrary, ECB President Mario Draghi can go ahead and fulfill his dovish promise of more quantitative easing, which should help equities in the single currency area.

Investors have been putting money into eurozone stocks since the beginning of the year, making the region the star of capital inflows this year. With interest rates still at record lows, returns on various assets, such as bonds, are more and more difficult to find, so strategists recommend that investors look carefully at dividend yields when assessing buying opportunities.

Analysts at Bank of America Merrill Lynch have identified four reasons for investors to turn towards dividend plays in Europe:

  • Valuations are attractive. The Stoxx 600 index representing large, mid- and small-cap companies in 18 European countries trades on a 2016 PE ratio of 14.6, with a 2016 estimated dividend yield of about 3.8%. The spread between equity dividend yield and the average yield on European credit markets is high, currently at 2.3%; the spread had been lower 93% of the time since 2004, and historically was largely negative. For financials, the equity dividend yield spread vs. credit yield is even higher, at 3.1%; it was lower 94% of the time since 2004.
  • Short-term uncertainty. This is a factor that could support high-yielding stocks of a high quality. Uncertainty over macroeconomic worries, such as the slowdown in China and weaker data from emerging markets, as well as the Fed's interest rate policy, could cause "choppiness" in the markets, but yield strategies should be favored. They outperformed both during the 2013 taper tantrum and throughout the range-bound markets of last year.
  • Deflation. A deflationary environment, with PMIs indicating expansion -- above 50 -- but low inflation expectations, is bullish for yield strategies because companies' earnings may grow, unhindered by the threat of interest rate hikes.
  • Catching up with bonds. In the eurozone, around 2.6 trillion euros ($2.8 trillion) worth of debt currently has negative yields, and equity market yield stocks have lagged the recent rally in government debt. New highs in negatively yielding debt have not been matched by new highs in low-risk dividend stocks so far, which means there's room for stock prices to appreciate.

For strategists at HSBC, one important attraction of high dividend yield stocks is that they offer diversification across sectors, from utilities to materials, energy and telecoms. "This diversity is likely to make [high dividend yield stocks] more resilient to macro developments than other styles such as quality or growth, in our view," they said.

Some of their top European stock picks for a high dividend yield strategy are: Adecco (AHEXY), with a yield of 3.1% and a dividend cover ratio of 2.2; AstraZeneca (AZN), yielding 4.5% with a 1.5 ratio; and Siemens (SIEGY), with a dividend yield of 3.9%, covered 1.9x by earnings.

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