What matters most when it comes to deciding if a share is right for your portfolio?

Valuation may play a role. The quality of the business may be a consideration. But before you get to those things, it’s important to ask whether the share fits with the financial goal you are trying to achieve.

If your goal is to build a stream of passive income, it’s unlikely that a share with no dividend will fit the bill. Likewise, if you are targeting long-term capital growth, you might lean towards companies that can invest more of their profits back into the business. This article is for those of you in the first camp.

My source material was Morningstar’s recently updated list of Australia and New Zealand Best Stock Ideas (available for Morningstar Investor subscribers). I've identified some of the shares on that list with the highest forward dividend yield.

Aurizon ★★★★

Moat rating: Narrow
Price to Morningstar Fair Value: 0.8 (undervalued)
Forward yield: 5.1%

Aurizon (ASX:AZJ) is a bulk-haulage and railway business that derives most of its profits from transporting coal. A major part of Aurizon’s business is the Central Queensland Coal Network, or CQCN, which provides essential transport infrastructure for the main metallurgical-coal-mining region in Australia. The CQCN is leased from the Queensland government until June 2109, with competitor access and access charges strictly regulated by the Queensland Competition Authority.

Aurizon’s haulage volume was weak in fiscal 2023 because of wet weather, but Morningstar’s Aurizon analyst Adrian Atkins thinks volume will recover and haulage tariffs will rise with the Consumer Price Index. Higher interest rates also mean the regulated rail track is allowed higher returns. Atkins thinks that concerns regarding falling demand for the coal transported by Aurizon are overblown. Aurizon largely hauls coking coal (used in steel production), and a commercially viable alternative for that looks a long way off.

According to Atkins, shares of narrow-moat Aurizon offer an attractive yield, underpinned by high-quality rail infrastructure and haulage operations. He thinks that a lot of pessimism is baked in at current prices, giving an opportunity for investors to buy a better-than-average-quality company at a discount. At a price of around $3.80 on 6th May 2024, Aurizon traded roughly 20% below Morningstar’s Fair Value estimate. This represents a potential 5.1% forward dividend yield based on analyst estimates. Aurizon’s last dividend payment was 60% franked.

Ventia Services ★★★★ 

Moat rating: No Moat
Price to Morningstar Fair Value: 0.84 (undervalued)
Forward yield: 4.90%

Ventia Services (ASX:VNT) is a leading infrastructure maintenance services provider in Australia and New Zealand. It is structured across four sectors including defence & social infrastructure; infrastructure services; telecommunications; and transport.

In Australia, Ventia services 50% of the private motorways and tunnels, and over 70% of defence sites. In New Zealand, it provides services to over 90% of the electricity transmission network. Ventia is also the number one telecommunications infrastructure services provider in both Australia and New Zealand.

Morningstar’s Ventia analyst Mark Taylor thinks that Ventia’s poor performance since its IPO is partly down to a large and declining vendor shareholding. He sees a lot to like about the company and the shares at current levels. Ventia’s deep pool of talent and large subcontractor base allows them to scale the workforce up and down on short notice. This plays into Ventia’s capital-light business model, with capital expenditure typically less than 1% of total revenue.

Over the next four years, macro tailwinds including population growth, increased outsourcing and environmental regulations underpin Ventia’s expectations for mid-single digits annual growth in their addressable market. Taylor projects EPS growing at a near 4.0% CAGR to 2026 and a fully franked yield nearing 7.0% by 2026. At a share price of $3.57 on May 14th, Ventia offered a forward yield of 4.90% and was trading at a 16% discount to Morningstar’s estimate of fair value. Their last dividend was 80% franked.

TPG Telecom ★★★★★

Moat rating: Narrow
Price to Morningstar Fair Value: 0.66 (undervalued)
Forward yield: 4.0%

After merging with Vodafone in 2020, TPG Telecom (ASX:TPM) joined Telstra and Optus as Australia’s third heavyweight telco. Morningstar analyst Brian Han thinks TPG shares screen cheaper than any other company under our telecoms coverage in Australia and New Zealand. Although the rollout of Australia’s National Broadband Network (NBN) poses a real threat to profitability in TPG’s consumer broadband segment, he thinks TPG earnings can recover over the medium term thanks to a more rational mobile market and growth in its fixed wireless and corporate segments.

Our analysts have assigned TPG a narrow moat due to the scale of its fibre infrastructure and existing customer base in Australia. This means that TPG can spread the costs of technology upgrades, advertising and content rights bidding over a large customer base, which reduces per-subscriber costs and puts TPG in a superior position against many competitors. The capital costs required for a new entrant to replicate even a small part of TPG’s infrastructure, scale, and brand power would be prohibitive, especially in a relatively small country such as Australia and a relatively mature industry with low single digit annual growth.

TPG’s shares have been weighed down by slower earnings growth as it invests heavily in rolling out 5G. There have also been some concerns of major shareholders selling down their positions after the post merger lock-up period. Han thinks these concerns are more than reflected in the share price, especially given the longer-term tailwinds from 5G adoption and TPG’s increased focus on mobile. At a price of $4.40 on May 14th, TPG’s shares were around 33% below Morningstar’s estimate of fair value. This represents a 4.0% dividend yield, which was 50% franked in 2023.

A warning on dividend yields

It would feel wrong to bring up dividend yields without mentioning the risks of being seduced by a high backwards looking yield that won't continue into the future. I wrote on how to avoid dividend disaster to help you avoid situations like this. And as I’m writing about dividends, it would be rude not to mention the work our very own Mr Income, Mark LaMonica.

Go here to read why Mark is an income investor. Or go here to see Shani and Mark discuss how to structure your portfolio for income.

You can find other undervalued share ideas here: