Big Dividends
There isn’t often a week which goes by where I don’t get asked about the best dividend stocks to watch out for. It’s a subject matter which I’ve ignored for too long now!
However, there is good reason for it. You see the trouble is, I’ve never been a huge advocate for dividend investing. Don’t shoot me down yet, hear me out and let me explain.
Not to say there aren’t wonderful passive gains to be made from dividend investing over the long term, but it’s just an area which can be laden with booby traps if you’re not careful. I understand this sounds slightly counter-intuitive considering the healthy dividend paying stocks are normally meant to be the steady Eddies of the market.
For a newbie investor looking to reap the pay-outs from the FTSE 350, the first port of call is to do a quick Google search and find a website which lists the highest dividend yielding companies and take the promise of chunky bi-annual cash rewards at face value. One must then assume the suspiciously high 9% dividend yield has no hidden red-flags, crack open a bottle of sparkling wine and make a toast to their latest shrewd investment.
If only it was that easy.
“But from there on, their usual cash generating business efforts of selling fruit and veg haven’t exactly built the share price back up to its former highs.”
Before we can get to the good part about which 4 stocks I think should be on your watchlist for a healthy dividend portfolio, it’s important to address the pitfalls and potential risks. So next time you know what to look out for and what to avoid!
Will the Dividend Destroy the Share Price?
When a company goes ex-dividend, it simply means the stock is now trading without the value of the previously declared dividend. For example, when Tesco recently awarded investors with a bumper 50.93p dividend per share, the day it went ‘ex-dividend’ exactly 50.93p also left the share price. So long, farewell, auf wiedersehen and goodbye to that cash amount, which I’ve demonstrated below with the use of two very concerned emojis.
Now it’s important to remember, when the special dividend was announced weeks before it left the share price, it could be argued that Tesco had a nice little run up, with investors seeing it as a good excuse to pick some up shares in order to take part in the cash reward.
But from there on, their usual cash generating business efforts of selling fruit and veg haven’t exactly built the share price back up to its former highs. Still laying low in the doldrums. And with that, you can see it can sometimes turn out to be a zero-sum gain. So it’s important to keep this in mind and cast an eye over their forecast revenue and earnings growth to make sure they’ve got more left in the tank; if only to help their share price climb back up.
Can the Company Live up to their Historic Dividend Yield?
When seeking a quote for current dividend yield, you’ll normally be presented with a percentage yield which is based upon what they paid out in the previous financial year – or the trailing amount.
Now, that’s all well and good providing the company’s fortunes haven’t taken a nose dive since then.
But therin lies a small problem, if you’re seeing a suspiciously high dividend yield it’s normally because the share price has indeed taken a big tumble. And if the share price has taken a big tumble then the chances are that the company’s fortunes have indeed taken a hit.
A perfect example of this is when Carillion were still trying to keep face and claim they were able to maintain their historic dividend pay-out just months before their ultimate collapse.
The market had lost faith and thus their share price had been battered with the company in complete disarray. But the quoted dividend yield was showing as 10%+ with Carillion refusing to officially cut the historic dividend policy.
The trouble is, if a company is seen to be cutting their dividend then this alone can cause more pain with a mass shareholder exodus and in turn a lower share price. So it’s not completely uncommon for a large listed company to hold off any dividend cut until the very last possible moment. This doesn’t mean to say you can’t trust the dividend yield you see on the screen and thankfully many companies are more transparent in their dividend policy and communicating any possible cut to investors.
However, there are ways in which investors can look for red flags and weed out any insincere dividend claims.
Total Debt vs Market Capitalisation
When total debt exceeds the entire value of the company, then alarm bells should be ringing.
Granted there may be instances when this is true of a high growth stock and their top-line revenue blowing investors expectations away. Naturally a high-debt business model might be expected if they’re over-delivering on revenue growth - after all, a tremendous amount of cash would be needed to offer such accelerated gains. But if it’s an established company with stagnant growth (or even worse, declining revenues) then this might be a sign of future pain.
Take Vodafone (VOD) as an example. Their total debt as of March 2021 sits at a worrying £67bn. More than twice their market capitalisation. In other words, you could sell every LSE listed Vodafone share twice over and they’d still have nearly £5bn in debt that would need paying.
Throw in the fact that they’re 5-year revenue CAGR (compound annual growth rate) is -2.53%, I’m not exactly enticed to take them up on their 6.92% dividend yield. Who knows, they may come good on this promise, but I won’t be parting with any of my cash to find out.
Quick Ratio and Current Ratio
Two very important metrics when assessing a company’s ability to meet short term liabilities that fall within a year. It’s important to look at these numbers when considering the likelihood of your promised dividend actually landing into your bank account.
Current Ratio = cash + inventory/liabilities due within a year
Quick Ratio = cash + near cash items/liabilities due within a year
An ideal Current Ratio should be 2/1 and at least a 1/1 Quick Ratio.
Because if they’re not well-equipped to meet short term liabilities, then is their dividend in danger?
Scanning through the big FTSE dividend yields, I’m presented with a glaring red flag from Imperial Brands (IMB). With a Current Ratio of 0.76 and a Quick Ratio of 0.35, they technically only have 76p worth of cash and roll-up cigarettes for every pound owed within the next 12 months.
Whilst at the time of writing IMB are supposedly offering a 9.22% dividend yield; I’m again filled with concern of a bigger problem at hand. Like Vodafone, I’m not denying for a moment that they won’t keep up with this yield but I’m exactly brimming with confidence either.
Dividend Cover
I’ll keep this one short and sweet as it’s a nice easy to understand metric if all else fails. Quite simply, it’s the Earnings per Share / Dividend per Share. And the dividend cover will give you a number of how many times a company’s earnings will cover their promised dividend pay-out.
You’d want to see this number to be at least above one as a bare minimum, but for it to be considered safe and well covered then the magic number is 2.
With all of that covered, I think it’s time to see who’s offering a juicy dividend and more importantly who can actually keep good on their promise?
Taylor Wimpey (TW.)
Ye Old Faithful housebuilder. The backbone of the UK economy through the good times and bad.
For a dividend play which hits on all the above metrics, Taylor Wimpey stands up to the toughest of scrutiny and has a lavish cash reward on hand to tempt new investors. Offering an ample yield of 5.42% for 2021 which is forecast to increase to 7.97% for 2022, I’d be crazy not to bring this to your attention!
What impresses me more than the generous yield is their financial strength and clear ability to meet on this promise. With a Current Ratio of 5.49, dividend cover of 2 and forecast revenues set to hit nearly £4.5bn for 2022, I struggle to find fault in what appears to be a very sizeable and equally sincere dividend policy.
It’s worth noting that there is some level of risk when considering the surge in raw material prices of late. If this trend continues, either the housebuilder will need to absorb this cost or pass it onto the end buyer which may slow sales. Higher underlying costs aren’t ideal but given their ending cash balance of £823m (as of year-end 2020), I still feel the dividend is here to stay.
Redde Northgate (REDD)
A van hire company who admittedly, I had not heard of until today. Not the most flattering of introductions, however upon discovery it looks to be a flourishing British growth story in the FTSE 250. After its merger between Northgate and Redde in 2020, revenues have increased 42% from £779m to £1.1bn (2021) with this top-line figure forecast to increase to £1.266bn for 2022.
Supplying commercial vehicles and automotive services to businesses, Redde Northgate is now well positioned to increase their current 3.76% dividend yield to an impressive 4.35% for 2022.
Solid 4%+ dividend yields are normally attached to the more uninspiring of the FTSE, but on this occasion it’s nice to see it comes with healthy revenue growth to boot. Whisper it, but if they follow through with their forecast revenue growth then Redde Northgate presents a very compelling low-cost growth stock with a forward Price/Earnings-to-Growth ratio of just 0.7.
Their 2022 dividend yield is covered twice over, Current and Quick ratio both above 1 and with revenues and net profit also set to increase by 14% and 34% respectively, I’m inclined to feel their dividend pay-outs have merit and are here to stay.
The purpose of this task was to avoid vanity yields with little integrity, but to seek out solid cash payers with the balance sheet to support their claim and, like Taylor Wimpey, Redde Northgate stands up well to the test.
Persimmon (PSN)
Back again with another UK housebuilder, Persimmon presents a very interesting 8.30% dividend yield which needs some unpacking but might not actually be too good to be true.
Like other UK housebuilders, Persimmon has been on the receiving end of an absolute boom period - no thanks to the cut in stamp-duty for home buyers. So much so that sales have actually risen above pre-pandemic levels which has meant their cash pile now sits at a staggering £1.3bn as of 30 June 2021.
Now with that in mind, I think it’s wise to not count our chickens just yet. Clearly, they’ve seen a surge in business but inevitably the market will calm down again post stamp-duty cut. However, in saying that, one interesting fall-out trend which has emerged during this pandemic is the diminishing popularity of metropolitan city living. Unlike London focused housebuilder Berkeley Group,
Persimmon cast their net further afield and may see home sales remain buoyant in light of this new work from home living choice.
I mentioned that their 8.3% dividend will need some unpacking and the quoted yield is partly based upon a special one-off dividend which allowed shareholders to partake in their up-tick in home sales. But if I strip all that out and go look at the investor relations section of their website, their base case scenario is to pay 125p per share to shareholders in 2022 but, ‘125p per share will be paid in early July 2022 and any surplus capital in relation to the financial year ended 31 December 2021 will be paid in late March/early April 2022’. Surplus capital are the important words in that sentence.
Even if they pay 125p in 2022, this still represents a yield on 4.32% (against a current share price of £28.93) which is not to be sniffed at. But if business remains healthy and they benefit from more non-city-centre buyers, then I suspect your faith will be rewarded with an extra dividend down the line. So, although an 8.30% yield should be taken with a pinch of salt, don’t be surprised if there are more goodies to come.
Keeping the share price moving in the right direction will always be a priority for Persimmon, and a sure-fire way to boost their valuation would be to surprise market speculators with a bump in dividend payments. Watch this space.
City of London Investment Trust (CTY)
Now if individual stock picking is a touch daunting for you, then you can always look to a well-managed Investment Trust which will sit on a large basket of equities and bonds to help spread the risk.
Quick 101 on what an Investment Trust is; In Layman’s Terms, it’s a company with shares that are listed on an exchange like any other quoted stock you’ll see in the FTSE 350. However, unlike FTSE 100 constituent Unilever who make their money from selling pots of Marmite, an Investment Trust will look to build up a portfolio of other companies like Unilever and create returns from leveraging upon the successes of other listed companies.
It’ll be ‘closed ended’ which just means there is a fixed number of shares but is open to anyone to buy or sell. And with that, it also means the Investment Trust can trade at a premium or a discount to their NAV (Net Asset Value) depending on if there are more buyers or sellers.
I’m a big advocate of Investment Trusts as it takes all the leg work out of the equation. It means you’ll have an incredibly qualified financial professional at the helm (Job Curtis in the case of CTY) making the important investment decisions, letting you get back to your daily task of telling colleagues their Zoom is on mute.
Now, I’ve singled out City of London Investment Trust for a few very good reasons. The primary goal of this article was to seek out above average dividend yielding companies and CTY’s memorandum couldn’t be more aligned.
Having read about their goals and objectives, I come away with a feeling of being in safe hands. I’ll try and summarise with a few bullet points;
Grown its dividend every year since 1966
Invests mainly in UK equities with a bias towards large, multinational companies
Dividend yield is first and foremost when valuing shares
90-125 different holdings
Looking at all their paid and due to be paid dividends for 2021, they’re stumping up 19.1p for the year which gives them a yield of 4.8%. And with their track record of increasing their dividend pay-out every-year since 1966, I’m inclined to believe this will move up again for 2022.
True to their word, their top holdings include large multinationals such as BAE Systems, HSBC and Unilever. All long-standing stalwarts of the FTSE 100.
With an ongoing management charge of 0.36% built into the share price and trading at a 1.83% premium to it’s NAV, the costs are low and the premium to NAV less than its 12-month 1.87% average.
Unlike Marmite, I struggle to see why any avid dividend seeker would find reason to hate City of London Investment Trust.
Honourable Mention
Having searched through several dividend focused Investment Trusts, one name which keeps popping up in their top holdings is Phoenix Group (PHNX) – the UK’s largest long-term savings and retirement business.
I was keen to mention them above but financial businesses such as Phoenix Group can be a little trickier to pull apart and metrics such as Current Ratio or Quick Ratio aren’t applicable due to items such as insurance liabilities and slightly more complex balance sheets.
But if we look at the strength of the business and their superb history of providing shareholder value through increasing dividends, then they’re very much worth adding to the watchlist.
Cash generation for FY20 (£1.73bn) was up 142% from FY19 (£707m), operating profit before tax jumped 48% to £1.199bn and their dividend payment for the year increased from 46.8p to 47.5p.
Honing in on their dividend for just a moment, this figure has been on a continuous but steady upward trajectory for the last 10 years.
Assuming that the 47.5p dividend is here to stay, this represents yield of 6.99%.
I kept this as an honourable mention because I must confess, like many other professed stock pickers, the financial intricacies of banks and insurance companies alike are sometimes best left to analysts who specialise in this particular field.
In saying that however, the average analyst rating for Phoenix Group across 11 brokers comes in at a cool 800p a share, 17% higher than its current share price of 679p which is a nice vote of confidence.
Please do your own research when looking at Phoenix Group along with all the aforementioned stocks, but their financial strength and strong analyst ratings are very promising.
If you’ve enjoyed this article and want to start your investing journey, feel free to reach out to me personally on t.sunderland@mittomarkets.com or call +44 (0)208 159 8985
Important Notice: When investing in shares, your capital is at risk. The value of the investment and any income from it can fall as well as rise, so you may get back less than your original investment.