As interest rates are cut again, investors may need to take a hard look at their portfolios. Only a few months ago, a rate hike had been expected to take place later this year or next. As a result, equity investors have been shifting out of higher-yielding stocks in favour of companies that promise faster earnings growth.
However, with interest rates now likely to stay lower for longer, investors may look at repositioning their portfolios again. Income is harder to come by, and equity investors should once again consider companies with track records of generous dividends, growing/stable earnings, low leverage and generous free cash flow generation.
So do the FTSE 100’s 3 highest-yielding stocks fit the bill?
Absolute dividend policy
At the top of the list comes housebuilder Berkeley Group (LSE: BKG), which promised to pay shareholders £2 per share in annual dividends until 2021, giving it a dividend yield of 8.1%. This is an absolute dividend policy, not pegged to future earnings, so investors should have confidence that the payout is at a low risk of being cut.
Housebuilder stocks may have plummeted by over 20% since the Brexit result, but trading updates from the sector show business as usual. Bovis Homes said its sales rate slipped near the end of June but interest from homebuyers has since picked up.
Moreover, Berkeley is in a strong financial position and nearing completion on several development projects. It has net cash of £107m and forward sales of £3.25bn, which should cover dividends over the next five years. This should minimise uncertainty over future house prices and accelerate the realisation of value in its portfolio.
The stock is attractively valued, with Berkeley on target to deliver £2bn in pre-tax profits over the next three years, which implies shares trade at roughly 6.4 times its average three-year forward earnings.
The world’s local bank
In second place, HSBC Holdings (LSE: HSBA) currently yields 7.2%. Its shares have bounced back strongly in the wake of the Brexit vote, up 22% since June 23 due to its large share of foreign earnings, which would no doubt benefit from improved sterling translation following the pound’s recent 12% slide against the US dollar.
Though further gains could be ahead with a strengthening Chinese outlook and an improvement in investor sentiment towards emerging markets, I’m worried about long-term dividend sustainability. While asset disposals, notably in Brazil, have improved its capital position, enough to even allow the bank to afford a $2.5bn share buyback programme, its dividend cover is shrinking.
It fell to just 1.3 times last year, down from 1.7 times two years before. Dividend cover could face further pressure as it faces near-term earnings headwinds, including rising loan losses and lower net interest margins. City analysts expect earnings to fall 15% this year, meaning dividend cover could drop to just 1.1 times this year.
Progressive dividend policy
Legal & General Group (LSE: LGEN) comes in third, with a yield of 6.4%.
Its shares fell 30% post-Brexit vote but have since recovered to 205p. Although that’s still 13% below its pre-referendum level, investors could expect further upside given its recent strong earnings trend.
Last week, it reported a 10% rise in first-half pre-tax profits, to £822m. Net cash generation rose 16% to £727m, underpinning confidence in its progressive dividend policy.
And well-respected fund manager Neil Woodford remains confident in the group’s future prospects, with his CF Woodford Equity Income Fund taking advantage of recent share price weakness to add more shares to its portfolio.
