Investing in dividend shares is one of my favourite passive income ideas. But, as investors are frequently told, past performance is not necessarily a guide to what may happen next. For example, last month a well-known UK stock that had offered a double-digit percentage dividend yield abruptly cancelled its payout altogether.
But I see reasons to think the juicy dividend might come back in future. So, should I add the shares to my portfolio now in hope of juicy dividends in a year or two?
Fallen star
The share in question is insurer and financial services group Direct Line (LSE: DLG).
Should you invest £1,000 in Direct Line 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 Direct Line made the list?
In one sense, the dividend cut should not have come as a surprise. The high yield offered prior to the announcement was a clue that at least some investors had doubts about its sustainability.
While the cancellation largely explains a 21% fall in the share price this year, it is also down 39% over the past year. Clearly Direct Line was losing popularity even while it maintained its dividend.
Business results had been wobbly. Revenues and profits both fell in its most recent annual results. In November, it reported declining revenues for the first nine months of 2022, but said that, “the outlook for dividend capacity remain unchanged”.
Bull case
It was therefore a shock that the company cancelled its dividend just a couple of months later. The core competence of an insurer is spotting risks in advance, after all.
That reflected incompetent management in my view. The former chief executive has since left.
But are things as bad as the cancellation suggests?
Direct Line remains solidly profitable. Cancelling dividends means that the cash the firm would have used to pay them is kept inside the business.
Demand for financial services is likely to be resilient. Direct Line has a strong brand that helps it attract customers. Its UK focus helps keep the business more simple than at global rivals.
It has proven in the past that it has the makings of a consistently profitable business that can fund large dividends. I expect under new management it will be able to do that again. That might see the meaty dividend being brought back next year if things go well.
Bear case
However, are the company’s woes just down to the former chief executive?
I question how effective the board of directors is, given the change in tone between November and January. No directors have taken advantage of the price fall since January’s announcement to buy shares on a substantial scale (there have been some fairly minor purchases as part of an incentive scheme).
Direct Line saw the number of policies in force decline 10.2% year on year in the first nine months of last year. That suggests the brand may have lost some of its shine.
Is this UK stock for me?
In the long term, I think Direct Line may have what it takes to get back to former profitability and dividend levels. If that happens, buying today for my portfolio could end up meaning I earn large income streams in future.
But I am not convinced the company will necessarily bounce back soon, if at all. It faces multiple challenges. I will pay close attention to its results next month — but will not be investing for now.
