Investing for income: Dividend yield and Dividend cover ratio

Investing for income: Where savers can escape zero interest rates
As deposit accounts pay next to nothing, dividends on shares seem attractive. But you'll need to choose carefully.

By Richard Evans Last Updated: 3:06PM GMT 06 Feb 2009
The Bank of England's decision to cut interest rates to 1pc means that many savers will now receive virtually no return from their money. As a result, many will be looking for alternative homes for their nest eggs. Among the options are dividend-paying shares.

"Cash-rich individuals will be scouring the stock market in search of a decent income from their savings," according to DigitalLook.com, the private investors' website.

Many large companies pay decent dividends once, twice or even four times a year. The yield – the dividend expressed as a percentage of the share price – is often attractive by comparison with interest rates on savings. There are now a wide range of blue chip companies yielding 4pc or more, DigitalLook said.

When comparing a dividend yield with the interest rate on a savings account, however, certain warnings should be borne in mind.

1. The first point is that your capital is not guaranteed; share prices can and do fall.
2. Secondly, dividends can be cut drastically or axed altogether with little or no notice – and this can lead to a fall in the share price as well.

So just buying the shares with the highest dividend, without researching how safe that dividend is, can be a mistake.
"There are now a huge range of high yielding blue chips but it is best to look for a dividend that is less likely to be cut even if that company's profits fall," said Andy Yates of DigitalLook.

The long-established measure of a dividend's reliability is dividend cover: the ratio of net profits to the size of the dividend payout.

Generally, a cover ratio of at least two – meaning that the company has twice as much net earnings as the amount earmarked for dividend payments – is considered a strong indicator.

A high yield alone is not synonymous with a decent dividend.

Shares in Land Securities yield 9.5pc, for instance, but this reflects investors' concerns about the property market.

There are companies that analysts expect to have a good chance of sustaining their dividends. These include AstraZeneca, the drug maker, International Power and Sage Group, the software firm, according to DigitalLook.

Mr Yates pointed out that an increasing number of companies, including Xstrata, the miner, and JD Wetherspoon, the pubs group, have announced over the past few weeks that they are going to skip their dividends.

But careful research should enable investors to sidestep enough potential problems to build up a well diversified high-income investment portfolio, he added.

"If you carry out thorough research and pick the right shares, you will get better value for your cash than by leaving it in a savings account."

The table below is a selection of FTSE100 companies with a forecast dividend yield of at least 4pc and a dividend cover of two or more.
Source: DigitalLook.com. Based on averaged forecasts from analysts at over 20 investment banks and stockbroking firms as of Feb 5 – forecasts on dividends excludes all UK listed banks
Data as on 05/02/09 at 12.30

Forecast
Forecast

Name
Forecast Dividend Yield...Forecast Dividend Cover

Prudential
5.80% ...4.1

WPP Group
4.20% ...3.4

Next
4.70%...2.8

FirstGroup
7.40% ... 2.6

InterContinental Hotels Group
5.00% ... 2.6

International Power
4.80% ... 2.6

Thomas Cook Group
6.30% ... 2.4

AstraZeneca
5.60% ... 2.4

Rolls-Royce Group
4.60% ... 2.4

Whitbread
4.70% ... 2.3

Smiths Group
4.00% ... 2.2

Aviva
10.60% ...2.1

Reed Elsevier
4.20% ... 2.1

Sage Group
4.10% ... 2.1

TUI Travel
5.30% ... 2

Imperial Tobacco Group
4.20% ... 2

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