A fortnight ago we wrote about the whopping 33% of UK 100 stocks offering dividend yields of 4% or better; attractive returns you can’t really afford to ignore when compared to the pathetic interest rates offered by the high street banks. For a refresher see here. This generated much interest (pun entirely intended) about which corporates were yielding how much, information which we promptly supplied. And detailed discussions lead to additional questions about how you can be sure about dividends. Not whether they will be paid (cancellations are thankfully rare) but what yields to look at.

Firstly, you should never rely on historic yields. These are based on what a company has paid. Whilst perfectly good evidence of the track-record, you can’t buy past share price performance and you can’t buy past income. There’s also no guarantee the same dividend per share will be paid again; the most recent year may include an extraordinary/special dividend which inflates the yield. Investors should thus be wary of big changes in yields from one year to the next. A spike one year could be followed by a drop the next.

The important yield for you to concentrate on is the forward or estimated yield which represents market expectations for future dividend payments. After all you are buying shares for growth and income and, as they say, you drive by looking through the windscreen not in the rear-view mirror. Some investors look forward just one year, others look at the next two or three. There is still no guarantee that consensus will prove correct and that a dividend will be paid, but other metrics can be used to boost your confidence that the income and the yield you are hoping for will be delivered. Forecast dividend yields are the logical first port of call, but another metric can also be employed to be doubly sure.

‘Dividend cover’ refers to a company’s ability to pay dividends. It’s the market’s expectations for how much a company will generate in profits versus what it is expected to pay out in dividends. Essentially how many times the dividends could be covered/paid from the profits made. Think of it as how much wiggle room a company has before the dividend payout is in jeopardy. The higher the cover the less chance the dividend will need to be missed or cut. Companies will aim to sustain a multiple of 2x cover and numbers consistently below 1.5x may mean a company will struggle to pay out as much – even at all – in future years. Some investors prefer multiples of 3x. Others prefer even higher for certainty and the chance that the company can even increase payments in future.

In the same vain as a fortnight ago, our stats show forward dividend cover ranging from a weak 0.7x to a very solid 14.3x in 2017 and 1.0x to 6.0x for 2018. Looking at 2017-18, given that 2016 is almost over, we note 66% of the UK 100 has  what is regarded as a sustainable dividend cover of at least 1.5x and 40% with more than 2x. Whilst not majorly different to the 70% of stocks yielding 2%+ and 33% yielding 4%+ we spoke of a fortnight ago, it does allow you to filter that little bit further and add a layer of certainty to your investments. Think of it as a tiny bit more homework for something that could yield handsomely for years to come.

Once again, if you like what you’ve read click here to get access to our renowned research and ensure continued flow of such helpful analysis and tips.

Mike van Dulken, Head of Research, 21 Oct