I’m shopping for FTSE 100 stocks that offer high dividend yields.
As a starting point, I found a list of the biggest payers, yielding from 7.4% all the way up to 9.9%.
But I’m wary of falling victim to a bait-and-switch. What if I buy the stock today for its sky-high yield, only for that dividend to be cut a few months later?
Should you invest £1,000 in Legal & General 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 Legal & General made the list?
Here are two simple tests I use to try and avoid such a disappointment.
Payout ratios
First, I like to look at the payout ratio. This tells investors whether the company’s dividends are covered by earnings. If a company pays dividends that are not backed up by its earnings, it must be drawing down its cash reserves or even going into debt to sustain them.
This simple metric shows me right out of the gate that the FTSE 100’s highest dividend yielder, global investment manager M&G, paid out 20p per share in 2022 while earning -67p. That loss was blamed on “negative market movements from the volatility experienced in markets throughout a challenging year”.
| Company | Sector | Dividend yield | 2022 Payout ratio |
|---|---|---|---|
| M&G | Investment banking and brokerage services | 9.9% | negative |
| Phoenix Group Holdings | Life insurance | 9% | 63% |
| Legal & General Group | Life insurance | 8.6% | 50% |
| Vodafone | Telecommunications service providers | 8.3% | 120% |
| British American Tobacco | Tobacco | 8.2% | 98% |
| Rio Tinto | Industrial metals and mining | 8% | 65% |
| Aviva | Life insurance | 7.6% | 47% |
| Taylor Wimpey | Household goods and home construction | 7.5% | 52% |
| Imperial Brands | Tobacco | 7.4% | 85% |
Meanwhile, Vodafone paid out 120% of its earnings per share in dividends, as the telecommunications company’s earnings depressed by regulations from Brussels that put an end to roaming charges within the EU and the EEA.
British American Tobacco’s dividends were just about covered by earnings, with a payout ratio of 98%. That is far too small a margin for comfort in my view.
After applying the first test, I’m left with six contenders in the running: Phoenix Group Holdings, Legal & General, Rio Tinto, Aviva, Taylor Wimpey, and Imperial Brands.
Consistency is key!
Next, I’m looking to see how stable the dividend is. For this test, I’ll eliminate all the companies that have reduced their dividend payout at some point between 2016 and 2022.
That is not especially strict, considering there are plenty of so-called Dividend Aristocrats out there – that is, companies with 25 consecutive years of dividend growth.
| Company | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 |
|---|---|---|---|---|---|---|---|
| Phoenix Group Holdings (£) | 0.42 | 0.45 | 0.46 | 0.47 | 0.47 | 0.49 | 0.51 |
| Legal & General (£) | 0.14 | 0.15 | 0.16 | 0.18 | 0.18 | 0.18 | 0.19 |
| Rio Tinto (£) | 1.34 | 2.13 | 2.33 | 3.01 | 3.42 | 5.78 | 4.07 |
| Aviva (£) | 0.31 | 0.36 | 0.39 | 0.2 | 0.28 | 0.29 | 0.31 |
| Taylor Wimpey (£) | 0.03 | 0.05 | 0.06 | 0.04 | 0.04 | 0.09 | 0.09 |
| Imperial Brands (£) | 1.55 | 1.71 | 1.88 | 2.07 | 1.38 | 1.39 | 1.41 |
Phoenix Group Holdings and Legal & General are the only two that pass that test.
What next?
Having whittled down the list from nine to just two, I have given myself a more manageable workload.
I’ll now want to leaf through a few years’ worth of annual reports from Phoenix Group Holdings and Legal & General to better understand their businesses before making any decisions.
