Should FTSE 100 Investors Worry About 8% Yields At Royal Dutch Shell Plc & HSBC Holdings plc?

Is the FTSE 100 (INDEXFTSE:UKX) dividend yield at risk because of Royal Dutch Shell Plc (LON:RDSB) and HSBC Holdings plc (LON:HSBA)?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

How safe is the FTSE 100’s 4.2% dividend yield?

The answer depends on whether you believe HSBC Holdings (LSE: HSBA) and Royal Dutch Shell (LSE: RDSB) can maintain their current dividends.

Both stocks offer a yield of almost 8% at today’s prices.

Should you invest £1,000 in Taylor Wimpey right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Taylor Wimpey made the list?

See the 6 stocks

They’re also the two largest companies in the FTSE 100. I’ve calculated that dividends from HSBC and Shell currently account for 22% of all FTSE 100 dividend payments.

If HSBC and Shell cancelled their dividends, the FTSE 100’s yield would fall from 4.2% to 3.3%.

Of course, HSBC and Shell are very unlikely to scrap their dividend, but cuts are a real possibility. In the remainder of this article I’ll explain how this could affect investors in both companies and in FTSE 100 tracker funds.

Why are yields so high?

Ultra-high yields like these are usually seen as a sign that a dividend cut is likely.

Star fund manager Neil Woodford said in a recent interview that he believed both Shell and HSBC were paying unsustainably high dividends.

Shell’s 2016 dividend isn’t expected to be covered by earnings, while the firm’s forecast dividend for 2017 will swallow up 100% of expected earnings. This situation clearly isn’t sustainable in the long run, but it won’t necessarily lead to a cut.

Shell has low debt levels and can borrow money very cheaply. If the group is confident that profits will recover in two-to-three years, then it can probably afford to subsidise its dividend in the meantime.

Over at HSBC, the dividend outlook is slightly stronger. Earnings per share are expected to cover the dividend around 1.4 times in both 2016 and 2017. Mr Woodford’s view may reflect his aversion to the energy and banking sectors. On the other hand, it would be foolish to ignore the views of such a successful investor.

What happens if Shell and HSBC cut?

If Shell and HSBC each cut their dividends by 33%, then each firm’s forecast yield would fall to around 5%. This is in line with the five-year average yield for both stocks. In my view, both companies would still be an attractive buy with a 5% yield.

However, investors who have bought heavily in the hope that the current 7.9% yields will be maintained could see a big shortfall in their expected income. A £25,000 investment in each company would currently produce a dividend income of around £1,975 per year. A 33% dividend cut would reduce this payout to about £1,315 per year.

This highlights the potential risk of having an income portfolio with too few stocks. A big dividend cut can do serious damage to your annual income.

FTSE safety?

The dividend yield from the FTSE 100 is generally seen as being pretty safe, but Shell and HSBC’s outsized yields have created an unusual situation.

If both companies cut their dividends by 33%, as I suggested above, then I estimate that the yield from the FTSE 100 would fall 4.2% to 3.9%.

An investor with a £25,000 holding in a FTSE tracker fund might see their income drop from around £1,050 per year to £975. However, an investor with a £500,000 pension pot invested in a FTSE 100 tracker could see their annual income fall by £1,500 in this scenario.

That’s a potentially serious loss of income.

Passive income stocks: our picks

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of HSBC Holdings and Royal Dutch Shell B. The Motley Fool UK has recommended HSBC Holdings and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

These 4 FTSE shares have crashed hard. Which do I like today?

These four FTSE 100 stocks have plunged in value over the last month. But after this latest market meltdown, which…

Read more »

Investing Articles

1 FTSE 250 stock that analysts are calling a ‘Strong Buy’

The FTSE 250 can be overlooked by investors, but analysts believe this stock in particular could be undervalued by as…

Read more »

Close up of a group of friends enjoying a movie in the cinema
Investing Articles

I asked ChatGPT to name 5 FTSE shares for the perfect SIPP. Here’s what it picked

Harvey Jones called on ChatGPT to help him decide which shares would be right to buy for a well-balanced SIPP.…

Read more »

Investing Articles

Should I load up on Rolls-Royce shares after the 17% drop?

Rolls-Royce shares have pulled back sharply in the FTSE 100 in recent weeks, leaving this Fool to wonder if he…

Read more »

Investing Articles

Is this the best S&P 500 stock to consider buying in these volatile times?

With bullion prices still rocketing, I think buying the S&P 500's only gold stock is worth serious consideration right now.

Read more »

Young Asian woman with head in hands at her desk
Investing Articles

Yielding 7.25% but with a P/E of 186x! What’s up with the BP share price?

Harvey Jones thought the BP share price was a brilliant bargain but it's only brought him a world of trouble.…

Read more »

Asian man looking concerned while studying paperwork at his desk in an office
Investing Articles

Down 26% with a 7% yield! Could this little-known FTSE 250 gem make a comeback?

Mark Hartley considers the long-term prospects of FTSE 250 recruiter Page Group. Weak results have sent the price tumbling but…

Read more »

Investing Articles

Analysts are calling Diageo shares a strong buy! Are they mad?

Analysts still have faith in Diageo shares, with 10 of them giving it the highest possible stock rating. Harvey Jones…

Read more »