Avoid high yielders

People looking for investing income often talk about high-yielders more than 12% annual return. Securities with this yield are not hard to find. Names like NLY, AGNC, and a handful of foreign stocks are returning as high as 16% return. But do the numbers make investing sense?

There is no free lunch in high-yield investing. Most high-yielders hand dividend at the cost of high payout ratio to attract investors. As yield continues or stays at high end, the risk of unsustainable return increases because no re-investing capital to keep pace previous high yield. Therefore, double digit yield is the moth's fire. More reasonable approach is pick high single digit yield and long sustainable dividend track record.

An example is U.K. pharmaceutical company Astra Zeneca (AZN). It has increased dividend since 2003. Current dividend is $4.9/sh or about 6.2% yield. PE stands at less than 10 while industry average 16. AZN's operating free cash flow is back to uptrend. New CEO halted stock buyback program recently to focus on acquisition. Hence we can see investing activities has since slightly reduced. AZN is rumored to take over AMRN for its Vascepa to fill AZN's pipeline. AZN paid $1.1 billion in April 2012 to buy Ardea Biosciences. Prior to that, AZN purchased MedImmune in 2007 for $14.7 billion. It also would pay BMY $3.4 billion to co-research new diabetes drug. To offset these expenditures, AZN will outsource some drug development.

AZN bought back $2.3 billion of stock before stopped the planned $4.5 billion. It is assumed the company would use the rest to acquire new companies. Because AZN has a policy of paying 50% of earnings in cash dividends. That translates to about $3 to $3.2 dividend in 2013 if the expected EPS from $6 to $6.3 is realized, which is a confirmed forecast. This dividend makes AZN significantly undervalued compared to its peers. The company reiterated earning forecast in the last earning call.

Therefore, AZN is a more reliable income source.