Is your favourite stock in the dividend danger zone?

Everybody loves a juicy dividend but investors in these stocks might consider running for cover, says Harvey Jones.

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.

In today’s land of low interest rates, the dividend paying stock is king. The FTSE 100 is crammed full of stocks offering right royal yields of between 4% and 7%, crushing the meagre 0.43% now paid on the average easy access savings account.

Take cover!

However, some of these yields need careful examination, because companies are struggling to fund their dividends from cash flow. New figures from investment platform AJ Bell show that forecast earnings by almost half of FTSE 100 companies cover their dividends by less than two times for 2016.

Dividend cover measures the ratio of a company’s net profits against the total sum it pays in dividends to ordinary shareholders. Russ Mould, investment director at AJ Bell, says: “Ideally you want a company’s earnings to be twice the size of the dividend payment to give it a cover of 2.0. Anything below 1.5 times earnings cover will question the sustainability of the dividend should anything go wrong. Once cover dips below 1.0 the company is having to dip into cash reserves or borrow or sell off assets to pay their dividend.”

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

Worryingly, average dividend cover for the FTSE 100 has now fallen to just 1.47 and for the 10 highest yielders on the index it’s a meagre 1.22. Even more concerning, six have dipped below 1.0, and a surprising number of them are very big and popular names indeed.

Troubled waters

Oil giants BP and Royal Dutch Shell are both thinly covered. They yield a generous 7.5% and 7% respectively, but dividend cover is just 0.52 and 0.43, which clearly isn’t sustainable in the longer term. Mobile phone giant Vodafone has been one of the most popular income stocks on the FTSE 100 for years and currently yields 5.5%, but forecast earnings for 2016 cover that just 0.56 times.

BHP Billiton’s yield is a less impressive 2.1% but the mining giant is struggling to fund even this, with just 0.70 cover. Insurer Admiral Group pays 5.9% but with cover of just 0.90, while financial advisers St. James’s Place pay 3.3% but with just 0.99 cover.

Dividend doubts

So are any of the stocks in your portfolio? If they are you should be a little concerned about those dividends, although you probably won’t be surprised. BP and Shell have been hanging on by the skin of their teeth, waiting for an oil price revival that has stubbornly refused to come. Crude has now climbed above $50 a barrel, although once it climbs above $55 or $60 the shale drillers are likely to come gushing back.

Vodafone’s yield also looks vulnerable, forcing the company to fund it out of reserves, and I’m hardly reassured by forecasts that it will increase to 0.63 in 2018. Although safe for now, the dividend could come under pressure if Vodafone’s profits take a hit at some point.

Dangerous game

Some other big names are also thinly covered, notably those paying the largest dividends. Direct Line, for example, yields 8% but cover is just 1.02. Taylor Wimpey yields 7.4% with cover of 1.52. Legal & General yields 6.7% with 1.46 cover. Other companies with cover below 2.0 include Marks & Spencer (6.6%, 1.45), Pearson (6.5%, 1.08), Persimmon (6.2%, 1.71) and SSE (5.9%, 1.31).

Reinvested dividends have accounted for 65% of total returns from the FTSE All Share over the past 30 years but investors shouldn’t just simply chase the highest yield they can find: it has to be sustainable as well. So check whether your portfolio is slipping into the danger zone.

This AI stock is becoming a digital juggernaut in a £ 12.5 billion market!

🤖 Curious about the next big player in AI? 🤖

Our leading industry analysts have uncovered a trailblazing content platform that's revolutionising the industry with its unparalleled generative AI technology, setting new standards in creativity and efficiency.

Care for a sneak peek?

Trusted by global giants like Amazon, Disney, and Netflix, this innovative company is not just transforming digital media with AI-generated 3D content but is also capturing a significant share of a £12.7 billion market!

With a remarkable 62% gross margin, indicating exceptional profitability and operational efficiency, this company's growth trajectory positions it as a must-watch for savvy investors.

Best of all, we're offering exclusive access to the name of this game-changing stock, absolutely free!

Discover your free AI 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.

Harvey Jones has no position in any shares mentioned. The Motley Fool UK has recommended BP 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

Up 20% in a month, should investors consider buying Marks & Spencer shares?

Shares in retailer Marks and Spencer have surged ahead over the last month, despite a cyberattack. Roland Head takes a…

Read more »

Charticle

Here are the latest growth and share price targets for Nvidia stock

Ben McPoland checks out the latest forecasts for Nvidia stock to assess whether it might be worth considering for a…

Read more »

Growth Shares

Yikes! This could be the most undervalued growth stock in the FTSE 100

Jon Smith flags up a growth stock with a low price-to-earnings ratio and a share price back at 2020 levels…

Read more »

Abstract bull climbing indicators on stock chart
Investing Articles

3 beaten-down FTSE 250 shares to consider buying before the next bull market

Paul Summers thinks brave investors should ponder buying some of the FTSE 250s poor performers before they recover strongly.

Read more »

Investing Articles

Gold prices soar while the Fresnillo share price slumps. What gives?

With a gold bull market in full swing, this Fool argues that the falling Fresnillo share price may not remain…

Read more »

Investing Articles

2 FTSE 100 shares I’m avoiding like the plague right now

While the FTSE remains packed with opportunity, many of the index's blue-chip shares could be at risk as trade tariffs…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

Here’s how an investor could aim for a million buying under 10 shares

Christopher Ruane explains why doing less, not more, of the right things could be the key to success as an…

Read more »

Investing Articles

Could this new risk cause a stock market crash?

Tariffs and a potential recession are two major stock market risks right now. But there’s another risk that concerns Edward…

Read more »