Last month we wrote about what to avoid when you invest in dividend-paying stocks.
The short version is you should be cautious of high yields because they’re often a sign a company is having problems elsewhere.
Tobacco stocks, for instance, generally have high dividend yields but that’s more a reflection of the lack of faith investors have in the sector to thrive in the long-run than them being great businesses with stellar prospects.
But that doesn’t mean you should avoid dividend payers entirely. As we said in the article, high dividend paying stocks have historically outperformed their benchmarks more than those paying the highest dividends.
That means we need to be a bit like Goldilocks looking for the right bowl of porridge. Dividend payers can’t be too high or too low — they’ve got to be somewhere in the middle.
Sadly, and unlike Goldilocks’ breakfast, investing never provides us with the perfect fit. The following five stocks could be within that dividend sweet spot for you now, but they may not be in the future.
As the past year shows, filled with cancelled dividends as it was, nothing is ever guaranteed. So these five companies may be in the ‘just right’ category for now but the reason we diversify our income sources is because that can change. Just make sure to do your own research before buying anything.
It seems apt that a firm which makes lots of money from cleaning products and medical equipment should be the first on this list given the past 12 months.
Bunzl is one of those companies you probably interact with every day without even realising it. The conglomerate is active in a range of sectors, making everything from napkins for hotels to safety equipment for construction workers.
And even though its cleaning and medical businesses benefited from the pandemic, revenue at the company has been steadily growing for decades. Sales at the firm were £2.3bn in 2003. Last year they hit £10bn for the first time.
The company’s share price has risen in conjunction with that increase but debt levels have too, standing at £1.7bn at the end of the 2020 fiscal year.
Bunzl has paid dividends regularly during that time as well — and managed to increase them every year along the way.
Its current dividend yield sits at 2.4%. Not mind blowing, especially when you think the FTSE 100 average is 3%. But when you factor in the share price growth the firm has seen over the past couple of decades then it starts to look a lot more impressive.
The stability of its payouts also means Bunzl now sits among the elite group of Dividend Aristocrats who prize consistency over enormous income payments.
The feeling most people get when they see a firm like this is that the ship has sailed, such growth can’t continue and the company isn’t worth its now relatively high share price.
Saying this off the bat doesn’t seem entirely reasonable though.
Bunzl is a really diversified business and all the sectors it's active in look unlikely to be subject to any major technological disruption. Cleaning fluids, medical gloves and napkins are all probably going to be in demand for a while yet.
That doesn’t mean it’s guaranteed to continue growing, it may not. Just don’t write a firm off because it’s done well for a protracted period of time. As the likes of Microsoft and Pepsi show, success can go on for a while, even after people have said a company has peaked.
“My house is to me as my castle, from which the law does not compel me to flee,” wrote English judge William Stanford in 1567.
Three hundred years later Charles Dickens would mock the UK’s obsession with housing in Great Expectations, with Wemmick’s London home styled as a castle, complete with a moat and cannon.
And the intervening period hasn’t abated our love for housing either. That may explain why homebuilders like Bellway remain very popular with investors.
The FTSE 250 firm was having a tremendous run until the coronavirus hit. Sales had almost doubled to £3.2bn in the five years prior to the pandemic.
Margins were also regularly above the 20% mark and the company managed to steadily increase its dividend payments as profits rose.
This all changed last April as Bellway ended up seeing its sales fall by close to £1bn and profits drop by over 60% to £249m. The result was a hefty cut to dividends, from £1.50 per share to 50p. That represented a 2.4% dividend yield, about half of what the firm averaged in the prior five years.
All of this may be temporary though. Given the housing market boom we’ve seen in the past few months, it seems possible Belllway could be back to growth in the next couple of years.
One other appealing thing about the firm is that it has very little debt. Some companies have survived the pandemic but only because they’ve borrowed vast sums of money.
Paying that back will take time and reduce future returns. Bellway looks less likely to face these sorts of problems, thus making a return to higher dividend payouts faster than it might otherwise have been.
A note of caution though, the housing market is still effectively being propped up by government support measures. Once the scaffolding of stamp duty holidays and Help to Buy are dismantled the house builders will need to show they are sturdy enough by themselves.
That’s when stock picking, not sector picking, becomes even more important. Identifying individual winners in housing hasn’t been as important as accessing the whole space in the past year but holding firms with low debt and a decent forward order book seems prudent now.
Analysing a company like L&G isn’t always the easiest thing to do. The firm has its fingers in so many pies that it can be hard to say what’s going to do well and what’s not.
The company, which provides insurance, lending and wealth management services, was one of the few financial services businesses to maintain its dividend during the pandemic, albeit at a reduced rate.
And it has been a mixed bag for the business over the past 12 months too. Profits were dealt a £228m blow as a result of more life insurance claims and losses in the housing sector.
But its wealth management business seems to have fared well and the company also recouped £85m in reserves that, sadly for those involved, it ended up not having to pay out to annuity holders.
One of the downsides of investing in a business like L&G is that you’re probably going to be less likely to see strong share price growth.
The business is already very well established and, although it’s done well at growing its wealth management division, you aren’t likely to see the sort of expansion that you might with a smaller company.
Having said that, the firm has, as its pandemic dividend payments show, been a reliable holding for income seekers, with its payouts having risen steadily during the past decade. Despite the pandemic, the firm’s dividend yield is still a respectable 6.2%.
And that’s generally what a lot of dividend investors are looking for. Instead of buying into something riskier, which may have bright future prospects that lead to large-scale share price growth, they want a business with more security that can afford to pay out profits to shareholders.
That’s exactly the narrative that has put L&G on value investors’ radars over the past year. A low valuation, coupled with the opportunity to make gains just as the company’s price gets back to normal, has been too hard to resist for many.
It’s a similar story with Vodafone.
The telecoms behemoth has been a favourite for income investors for a couple of decades now and it has done a pretty good job at increasing its payouts during that time.
But Vodafone arguably falls into that suspiciously high yield category that we mentioned at the start of this piece. Although its 6% yield is slightly lower than L&G’s, it looks far less stable than the financial services business.
Part of the reason Vodafone’s yield is at that level is because its share price has fallen substantially in the past five years and that’s not because of the coronavirus.
Investors have been wary of the firm because it's sitting on a gargantuan pile of debt. Last November the telecoms firm had close to £40bn in debt and a market capitalisation of £31bn, meaning it effectively owed more money than it was worth.
The company floated Vantage, its mobile towers business, in March to try and do something about this state of affairs. That helped the group raise €2.3bn and chip away at its debt.
But a bigger problem is that returns aren’t what they used to be. A decade or so ago, companies like Vodafone regularly had a return on capital employed — a figure that tells you how much profit a company makes relative to its capital expenditure — of 40%. Today they are usually about a tenth of that.
This doesn’t mean Vodafone is doomed or on the brink of collapse. But it does make you wonder if it's as investment-worthy as it once was.
Dividend seekers may not care that much about share price growth but they would certainly be concerned if their investments lose the sort of value that Vodafone has in the past five years.
The commodities boom we’ve seen in the past couple of months shows why some investors are keen on companies active in the sector.
There’s also a perception, not necessarily an accurate one, that metals can protect you from inflation. Given some of the fears of currency devaluation we’ve seen so far in 2021, that’s probably put companies like Rio Tinto, with a dividend yield of 5.4%, on some people’s ‘buy’ lists as well.
But that doesn’t mean they’re always a great investment. Look back over any prolonged period of time and you’ll likely see regular dips and dives in the prices of most commodities.
That means anyone trying to make a quick buck can get seriously burned by trying to play the market.
It’s a little different for dividend seekers. Although they might have some bad years, businesses like Rio Tinto can say pretty confidently that there’s going to be demand for their products for the foreseeable future.
Yes, there might be dips and dives from time to time but the good years can often compensate for the bad.
Rio Tinto has a particular focus on copper, which normally serves as a bellwether for the global economy as it’s used in so many industrial and commercial processes.
Given the price of Dr. Copper is flirting with all-time highs, that’s good news for any firm that mines it.
A key area to watch will be China’s use of copper in the years ahead. The country’s ambitious infrastructure plans mean demand has been hoovered up as fast as it has been produced. If there is any fluctuation there it could hit the copper price and have a knock-on effect for the likes of Rio Tinto.