I’ve found that investing in dividend stocks is a great way of supplementing my income which doesn’t stretch as far as it once did, thanks to the cost-of-living crisis. But there’s little point buying a high-yielding stock if it’s in terminal decline. When it comes to picking winners, therefore, it’s a case of buyer beware.
Housing crash
Persimmon is a good example. The housebuilder has a reputation for paying generous dividends. The payout for 2021 was 235p per share. In March of that year, the company’s share price was over £32, giving a yield of 7%.
However, a downturn in the housing market caused its share price to tumble. By October 2022, the company’s stock was yielding 20.6%. Six months later, the directors cut the dividend to 60p. The shares now yield around 5%. This is still above the FTSE 100 average. But it’s a far cry from the figures being quoted towards the end of last year.
The apparently very high return offered by Persimmon’s stock was a warning that the company’s dividend was unsustainable.
What other high-yielding alternatives are there?
Digging and smoking
Historically, mining and tobacco companies have paid decent dividends.
For example, Glencore‘s stock is currently yielding close to 8%. However, its profits can be erratic due to volatile commodity prices. This means its dividends fluctuate from one year to the next. In good times it makes special (one-off) payments. But these are not repeated when earnings are lower.
Tobacco companies offer good returns to shareholders. Shares in Imperial Brands are currently yielding 7.5%. But the company’s dividend is now 30% lower than it was in 2019.
A better alternative might be British American Tobacco which has a higher yield (7.7%). Unlike its smaller rival, it has raised its payout to shareholders during each of the past four years.
I’ve no problem investing in smoking stocks, although I know some object on ethical grounds. My biggest concern is that governments around the world are placing increased restrictions on all types of tobacco products, including the newer so-called less risky variants. I fear this will reduce earnings — and therefore dividends — over the next few years.
Caution
Some companies pay the majority of their earnings in dividends instead of re-investing the cash in developing and growing their businesses. This produces eye-catching yields but, ultimately, could be self-destructive.
Last year, M&G paid dividends of £479m and completed £503m of share buybacks. Yet the company saw a net cash outflow from its operating activities. If sustained, this could be to the detriment of the company’s long-term growth prospects. However, its double-digit yield is alluring.
As consumers, we are often warned that if something looks too good to be true, then it probably is. That’s why I prefer less volatile dividend stocks like National Grid.
The owner of the UK’s electricity grid has been steadily increasing its dividend. Last year, it was 11% higher than in 2018. And it accounted for a conservative 39% of earnings. The stock should yield 4.7% this year. If funds permitted, I’d be happy to have this stock in my long-term portfolio.
I try not to be too greedy when it comes to choosing dividend stocks. Shares offering yields slightly above the FTSE 100 average are good enough for me.
