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Last year we dug into a list of the UK’s dividend paying stocks and offered up some thoughts as to why looking beyond eye-catching yields of 10% or more could be a good idea.
Our overarching message was that while seeking out the highest income-paying stocks is not necessarily a bad place to start, high yields can lure investors into a trap.
It's important to understand the risks that might lurk in the shadows of the high yield underground.
Dividends are sometimes thought of as passive income, but there is nothing passive about a collapsing share price due to a dividend being slashed.
Just ask shareholders of Imperial Brands who got hit with a dividend cut in 2015 after the company took on too much debt to fund acquisitions.
2021 was a good year for stock markets. As economies and consumers emerged from the pandemic, the financial fortunes of many companies continued to recover.
Some of the top paying companies made whole on their dividends in 2021. The result was they turned in a decent performance for the year in terms of total return (measured by the price performance of a stock plus the dividend - for example if over a year a £100 stock goes to £110 and also pays £10 dividend that would represent 20% total return).
Those top paying companies from 2021 also appear on 2022’s chart.
Past performance is not a reliable indicator of future returns
Source: Koyfin, as at 31st Jan 2022. Basis: bid-bid in local currency terms with income reinvested.
It’s important to highlight that this is a wrap-up and a guide and not a suggestion or recommendation that you buy or sell any of the securities mentioned.
Remember that everyone has their own goals and unique financial circumstances. These, along with your tolerance for investment risk and time horizon, should inform the mix of assets in your portfolio.
Our resource hub for investing in the stock market might be able to help make that blend a bit clearer for you and our guide on how to invest in stocks is a great start for first-time investors. And if you are still unsure of how to pick investments speak to a qualified investment advisor.
Evraz shares continued their strong run from 2020. A healthier commodity backdrop allowed the steel and mining firm to reward shareholders with some hefty payouts during the year. Dividend payments contributed nearly half of the stock's 48% total return for the year.
It's been a different story so far in 2022. Events on the border of Ukraine have taken over the Evraz narrative. It’s a timely reminder of why large payouts need to be considered alongside other risks.
Imperial Brands turned in a 15.2% total return in 2021. While strong, it lagged the broader index of top 100 UK stocks. Having already cut its dividend payout to tackle a high debt pile, Imperial comfortably earned enough profit to dole out its final dividend along with three interim payments.
2021 was a solid year for the homebuilder with housing activity climbing back towards pre-pandemic levels. Persimmon was able to deliver on its dividend promise, similar to Imperial, though its total return fell short of the broader UK market.
M&G offers financial products from insurance to asset management, and its healthy balance sheet should mean its payout is pretty safe for the time being. The stock returned roughly 10% in 2021 with most of this coming from the dividend payout, meaning it lagged the total return of the market.
Although things are going well for M&G right now, management is staying cautious given heightened uncertainty going forward. So investors looking for any meaningful ramp in dividend handouts might be disappointed.
Similar to M&G, most of BAT’s total return to shareholders came from dividends in 2021. But at a 9% return, this still fell short of the broader market.
Although in theory and based on their history of payouts, tobacco company investors should avoid seeing their dividends go up in smoke (again Imperial aside). But the industry faces significant challenges.
In order to grow or even maintain their current dividends, companies are turning to less harmful non-combustible alternatives to cigarettes. It remains to be seen, though, whether enough smokers will switch their habits to save the large dividend payouts currently on offer.
So although 2021’s top dividend payers had a decent year, they still underperformed the broader UK market and dividends made up the majority of their total return.
Our message stays the same then, which is that investors should consider more than just yield when opting for a dividend investment strategy.
With the exception of Evraz, the share prices of last year’s high yielders went sideways. This suggests that although investors might not fear imminent dividend cuts, they are perhaps less optimistic when it comes to their growth prospects.
This is important because in today’s inflationary environment, a static dividend is like cash in the bank and its value is eroded over time as prices rise.
Dividend growth, on the other hand, protects a company’s payout against rising price levels.
The challenge, of course, is that yield and growth are hard to find in one investment. More often than not, a high yield means that the company has little cash left over (after paying out the dividend) to invest in its business in order to grow profits (and the increased dividend payouts that follow).
So plumping for the fattest payout might seem like a good idea, but like the cheapest wine on the list, it could leave a nasty taste in your mouth.
A different approach might be to lower your eyes a little further down the payout list and consider a company, or an industry, that offers a better chance of a dividend pay rise.
The problem with the UK market is that the chart toppers, even those outside the top five, tend to be in industries that either lack the fundamental growth to support higher payouts in the future, or are in highly cyclical sectors that will struggle if economies sail into more troubled waters.
The updated top 10 dividend stock table is provided below, alongside some comments for consideration.
Source: dividenddata.co.uk 2022
Another option is to draw the cutoff line a little lower, trading absolute current yield for a safer payout and one that might have some growth prospects. A £15 house red for a £35 Rioja, perhaps.
Although we face some of the same problems in that the list consists of mostly mature companies, we can diversify away some of the cyclical risks that exist in sectors like metals and mining.
Source: dividenddata.co.uk 2022
Selecting dividend stocks from outside mature or cyclical sectors guarantees you neither growth nor safety, but it could give you a better chance of both.
There is always the option to pay a fee for a professional to do it for you. Here you would hope that the manager at the helm would have a decent chance of avoiding the worst of the dividend icebergs, and invest in some growers at the same time.
This is not a given, though, and it's just as important to do your homework on the professional managers as it is on individual stocks.
One advantage of the investment trust structure is their ability to reserve up to 15% of their income in the good periods so they can top up payments to investors when dividend income suddenly becomes hard to find.
The following list shows the current highest yielding investment trusts. Note that, as their names suggest, some of these trusts invest in equities outside of the UK market.
Source: ftadviser.com Nov 2021
Our message this year is similar to last year, in that opting for the fattest payouts alone is not an advisable strategy. Investors need to consider the safety of the payout as well as its growth potential.
These considerations are even more important for 2022 given the rise of inflationary pressures which will erode a static dividend, and the potentially choppier economic waters ahead.
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