Investment wisdom for income-seekers

7th December 2011

If you're a dividend investor who's in it for the long haul, says The Motley Fool, what your stock pays you today isn't nearly as important as what it'll pay you in the years to come. "While today's highest-yielding investments may turn into tomorrow's dividend busts, some lower-paying dividend stocks hold the key to huge future riches."

But how can you find the decent dividend-paying shares – with longevity?

 

Seek the safe stocks

Nick Kirrage, manager of the Schroders Recovery Fund and Mindful Money blogger says: "There are many schools of thought when it comes to income investing but, within them, there are some elements of conventional wisdom that income-seekers would do well to challenge – the first of which is that large, high-yielding companies are inherently safe.

"There is an enormous concentration of dividend yield in the top 20 UK stocks. These companies are amongst the largest and most well known businesses in the country, but that doesn't necessarily make them safe. To our mind, safety is about indebtedness, for whilst all businesses can have an accident or fall on hard times, it is usually the companies which have too much debt that never recover.

"BP is a great example of this, though not in the way you might think. BP isn't an example of big stocks being unsafe, but in fact one of a prudent balance sheet ensuring survival. Were it not for the strength of BP's balance sheet and its conservative approach to debt and financing, it would in all likelihood have gone bust after taking such an enormous hit from the Macondo disaster."

 

Beware debt levels

Kirrage continues: "However, there are a number of other businesses among the UK's largest companies that appear cheap but have huge amounts of debt. Debt is actually rather perverse because it can help boost a company's fortunes when times are good but, if something goes wrong – no matter how unlikely that event – it will only magnify the problem and may wipe a company out. Debt is no respecter of size or reputation. With too much debt there is simply is no margin of safety."

 

Look beyond headline yield

James Henderson, Henderson's UK Equity Income fund manager, adds: "Income growth really matters – often investors focus on a high yield rather than the potential for growing dividends. Companies either go forwards or backwards, they don't usually go sideways.

"Investors across the globe have opportunities to buy stock with growing dividends – for the UK market, 8-10% of the companies listed on the FTSE All-Share will see dividend growth in 2012. The reason for that is a lot of corporates have paid down debt, and capital spend numbers aren't high – and reasonable profits are leading to companies increasing dividends, having brought them back in 2008 and 2009.

Turning to which sectors investors might want to consider for growing dividends, Henderson says: "There is a rebalancing away from the consumer sector and we are seeing growth in manufacturing."

 

So what tools can you use to make the choice?

Launched last year, the UK Dividend Achievers index has produced an annualised return of 12.59 in year to July 2011. This performance translates into an absolute return of £1,300 for those who invested £10,000 a year ago.

The latest UK Dividend Monitor from Capita Registrars shows dividend payments in the UK are on the increase, with 247 companies paying dividends in the second quarter, compared with 221 in the same period last year. However, investors need to seek out consistent dividend-paying companies, not just those making high, sporadic payments.

Dividends from the ten biggest UK-listed stocks – HSBC, Vodafone, BP, GlaxoSmithKline, Royal Dutch Shell, British American Tobacco, Rio Tinto, BG, BHP Billiton, and AstraZeneca, account for almost half of the market's total income, and many of these are a good bet.

National Grid is one of the highest yielding stocks from a list of the top 100 dividend-paying companies in the UK, says FT Adviser. It returned an impressive yield of 7.2 per cent to the end of July and is therefore one of the shining lights of the UK Dividend Achievers index, composed of UK companies that have increased their annual regular cash dividends over the past five or more consecutive years.

Vodafone Group was another of the biggest payers of dividends in the FTSE 100, with a total of £6.7bn to be handed to shareholders this financial year as the British mobile phone network passes on cash received from its US subsidiary.

 

More from Mindful Money:

Alternative thinking – income investors should benefit from challenging conventional wisdom

Does political climate effect your investment strategy?

Market crash: The secret to investment timing

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