The average dividend yield on the FTSE 100 is just 3.4%. But I’ve found three stocks with 8% yields that I’d be happy to buy for my portfolio today. I’ll look at these stocks in a moment, but first I want to explain why I think they’re looking so cheap.
In my experience, a very high dividend yield can mean a couple of things. One possibility is that the company is unfashionable and slow growing, but still very profitable. Tobacco is the classic example of this in today’s markets. For a value-minded investor like me who also wants income, buying these shares can make sense.
However, some stocks have high yields because the market expects a dividend cut. These are the shares I try to avoid.
I reckon the three companies I’m looking at today all offer sustainable dividends. I already own one of them and would be happy to buy the other two for my Stocks and Shares ISA.
Making good progress
My first 8% yielder is FTSE 100 stock British American Tobacco (LSE: BATS). I admit that this company won’t be popular with all investors. But BAT’s business has proved surprisingly long-lived. Despite a global decline in smoking rates, it continues to generate stable profits and generous cash flows.
BAT brands such as Camel, Rothmans, and Lucky Strike are familiar the world over. But the company doesn’t plan to rely on them forever. Investment in non-combustible products such as vapes has increased and is starting to deliver results.
The number of customers buying so-called new category products rose by 3.6m to 17.1m during the first nine months of this year. Although that’s still a small number compared to the number of people who smoke cigarettes, I think it’s a decent rate of growth.
CEO Jack Bowles says that BAT’s new category business is on track to become profitable by 2025. From that point onwards, profits from products such as vapes should help to offset any weakness in tobacco sales.
In the meantime, BAT’s 40% profit margin means that it’s generating enough cash to support the dividend and fund a gradual reduction in debt.
The main risk I can see is that smoking rates will fall faster than expected, perhaps because of tougher regulation. If younger generations keep away from nicotine altogether, then the outlook could become very gloomy.
I’m not taking an ethical view on this, but in practical terms I think it’s unlikely. In my view, BAT’s 8% dividend yield is likely to remain safe for the foreseeable future.
A golden 8% yield?
My second pick is FTSE 100 gold miner Polymetal International (LSE: POLY). This business owns and operates a number of gold mines in Russia and Kazakhstan. The firm is something of a family business. Around 24% of the stock is owned by Russian billionaire Alexander Nesis, who is the brother of chief executive Vitaly Nesis.
I’m usually cautious about investing in Russia, due to the political risks of this unusual market. But Polymetal has been listed on the London market since 2011 and has a solid track record, in my view.
Between 2011 and 2020, Polymetal’s annual profit rose from $289m to $1,086m. Some of this growth was due to the gold price rising from 2018 onwards. But some is due to underlying growth in the business, as new mines have started up.
Polymetal produced 851,000 gold equivalent (GE) ounces in 2011. The company’s guidance for 2021 is 1.5m GE ounces.
While production has grown, costs have remained fairly stable — and low. Polymetal’s total cash cost of production was $701 per ounce in 2011. The figure for 2021 is expected to be between $750 and $800 per ounce.
These are relatively low costs for a gold miner, in my experience. With gold trading at $1,785 per ounce as I write, it’s clear that Polymetal should be generating plenty of cash.
The company’s policy is to return cash to shareholders as dividends. When gold prices are high, these dividends are generous. This year’s forecast payout of $1.35 per share gives a yield of 7.8% at current levels, for example. Next year’s payout is expected to be higher.
The flipside of this situation is that shareholders cannot expect stable long-term dividend growth. When the gold price crashes, as it did in 2014/15, the dividend is likely to be cut. I’m happy to accept this risk, but it’s certainly not something to ignore. In my view, the cyclical risk here is one of the reasons why Polymetal’s yield is so high.
An unloved 9% yielder: too cheap?
My final pick is a company that’s been through some big changes in recent years. Fund manager M&G (LSE: MNG) was previously part of insurer Prudential. M&G was spun out into a new FTSE 100 business in October 2019.
The performance of the business has been sluggish in recent years, but I think it’s showing signs of improvement. M&G’s adjusted operating profit rose by 6% to £327m during the first half of this year. Meanwhile, the value of the group’s assets under management edged up to £370bn during the period.
Of course, the first half this year saw broad increases across the UK stock market. I’d expect a fund manager’s performance to improve in these conditions. I’ll be keen to see if M&G has held onto its gains during the second half of the year, which has been much more difficult for investors.
This isn’t an easy business to analyse, as M&G’s profits depend on stock market performance and the level of inflows and outflows from its funds. Even so, I think the shares are priced very cautiously at the moment.
Broker forecasts price M&G shares on 8.5 times 2021 forecast earnings, with a 9.3% dividend yield. Unless the company’s performance goes horribly wrong, I think the shares have the potential to move up from these levels in 2022. This is certainly a stock I’m watching as a potential bargain buy.
