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With the interest rate on savings accounts lower than a slug’s belly, it is tempting to look to London’s blue-chips for some sexy income.
There are certainly some thumping dividend yields – that’s the dividend per share expressed as a percentage of the share price – available among the Footsie’s constituents, many of which look too good to be true.
Steel-maker Evraz PLC (LON:EVR) appears to be offering a yield of 17.0%, fags maker Imperial Brands PLC (LON:IMB) a yield of 16.9% while oil leviathans BP PLC (LON:BP.) and Royal Dutch Shell PLC (LON:RDS) both yield more than 16%.
Passing the sniff test
Generally speaking, any yield over 6% should set alarm bells ringing, with the thinking being that such high yields are unsustainable.
Yet even if we calculate a forward dividend yield, based on what brokers think the companies will pay out over the next 12 months, the yields for Evra, Imps and BP still only fall to 8.1%, 11.7% and 10.7%, respectively.
Shell just about passes the sniff test with a projected yield of 5.4%.
There are other ratios to take into account, though. One is dividend cover, which is earnings per share divided by the dividend per share but as many stock market followers know, earnings per share numbers can be manipulated, which is why some of them insist company profit & loss accounts be kept in the fiction section of the local library (if it is still open).
Cash is king, those doubting Thomases cry, and they look to see how well free cash flow (FCF) per share covers the dividend payout.
Evraz clocks in with FCF cover of 1.4; IMPS 1.3, BP 1.2 and apparent golden boy Shell 0.9, which means it is not generating enough cash to cover its dividend payments.
Historically, Shell’s directors have been prepared to gnaw their own arms off rather than cut the dividend but the company did so recently, in recognition of the changed environment, namely the coronavirus pandemic and the concomitant slump in the demand for oil, so no matter how safe a dividend looks, bear in mind it is not cast iron.
No one is suggesting that there will be a slump for tobacco products, much as we might wish it, which might make IMPS a better bet for reliable income; the company has increased its dividend for 22 years in a row.
That forecast yield, though, of 11.7 really sets the alarm bells ringing. Sector peer British American Tobacco PLC‘s (LON:BATS) forecast yield of 8.8% is a bit more sedate, and like IMPS, its FCF cover, at 1.4, is acceptable.
Got you covered
If we turn things on their head and just look at free cash flow dividend cover then sportswear retailer JD Sports Fashion PLC (LON:JD.) is top of the tree with a barely believable cover of 251 times its dividend. Unfortunately, it is yielding a paltry 0.1%.
Clearly, we need to filter out some of the low payers and some of the absurdly higher payers to get a Goldilocks selection.
Screening out stocks with a forecast yield of more than 6.5% and less than 4% generates 21 Footsie stocks with decent yields.
Top of the tree is SSE PLC (LON:SSE), with a forecast yield of 6.5% and a free cash flow dividend cover of just 0.1. The reasons for holding a utility for anything other than the dividend would fit on the back of a postage stamp – ask your Dad what one of those is – so investors looking for the prospect of a soupcon of share price growth might care to look elsewhere.
For instance, Polymetal International PLC (LON:POLY), the precious metals miner, which boasted of record quarterly free cash flow in the third quarter of this year.
Its projected yield is 6.3% and its free cash flow dividend cover is 0.8, which is a bit worrying although it has grown dividend pay-outs for the last six years.
In third is GlaxoSmithKline PLC (LON:GSK), the drugs giant that is not only in a sector unlikely to be affected by the coronavirus pandemic, it might even benefit from it.
Its projected yield is 6.2%, its free cash flow dividend cover is 1.4 and its debt (including its pension deficit) to free cash flow is just 6.2, which puts it at number 7 in the 21 stocks generated by our stock filter on that particular ratio.
The rest of the list has a healthy representation of supermarkets – always a favoured choice of risk-averse investors – and housebuilders, whose directors must have some seriously compromising photos of prominent politicians given the publicly-funded largesse the companies have received over the last decade or so.
There a few asset management firms in the list – Schroders PLC (LON:SIR), St James’s Place (LON:STY) and Intermediate Capital PLC (LON:PIC) – which might be expected to take a hit if stock markets collapse during a second wave of coronavirus cases but they are nothing if not survivors and investing for dividend income is a long-term game.
Notes:
[1] Higher is better
[2] Lower is better
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