UK stocks offer some huge dividend yields at the moment. A quick look shows me companies with 8%, 9% and even 10% returns. I’d love payouts as high as that, but they can be a big red flag.
A high yield can be dangerous. A big payout can mean a deflated share price which is a sign the stock is unwanted, in distress, or even headed for major trouble.
Consider Persimmon (LSE: PSN) for a second. The housebuilder had been one of the FTSE 100’s best performers since the crash in 2008. Then last year, it offered a bumper 15% dividend yield. That’s a massive payment and, yet, I’m glad I didn’t buy in.
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I expected the housing sector to have a rough year. Interest rates were shooting up and the stamp duty holiday had ended. It’s a cyclical sector, so boom and bust periods like this are normal. But still, I saw Persimmon as a risky buy.
Thanks to these issues, the shares fell 32% and its dividend yield was slashed to 4.9%. As an extra kick in the teeth, the firm got booted out of the FTSE 100 a week ago. I would have been counting some heavy losses if I’d gone in on that 15% dividend.
Since then, I think the stock is much better value. I picked up a few shares recently even with the lower yield.
Looking at today’s big yields, Vodafone (LSE: VOD) offers the highest Footsie payout at 10.5%. So is there danger here too? Or is this a great buy?
Overwhelming evidence
Well, the Vodafone dividend is an interesting one. It has stayed stable at 9¢ per share (in cents as it reports in euros) for five years. While that sounds good, a strong company will be increasing its payments, not keeping it at the same amount.
The firm is struggling to make those payments too. Last year’s payout was covered by 1.1 times adjusted earnings. So the firm is spending almost all its profit on dividends. I don’t see that as sustainable.
Debt levels are high, and analysts predict a decline in dividends in the years to come. The evidence seems overwhelming to me. Vodafone is a risky buy.
A safer dividend, on the surface at least, comes from Aviva (LSE: AV). I could get an 8.61% payout, which is still generous and the seventh highest on the Footsie.
A bright future?
Unlike Vodafone, Aviva has a strong record of increasing dividends. Over the last 10 years, the dividend had an 8.1% average 10-year growth rate, so that’s a positive. Last year’s payment was made from 1.9 times earnings too. That seems safe to me.
It’s true that finance, like housing, is a cyclical sector. Aviva has reduced its dividend in previous crises in 2008 and 2020, and this year’s global banking issues aren’t a good sign for the insurance provider. I see this as the biggest risk here.
On the other hand, the stock is at a 52-week low so this could be a great time to buy in. All in all, I’m confident the future is bright and the dividend isn’t a value trap. I own a position and if I had spare cash, I’d buy more too.
