Checking the safety of dividend payments

Dividends are an important part of total returns from owning a share.  

Dividends are a cash payment and therefore the company needs to have enough cash flow to make these payments.

Compare the FCF with its dividends

By comparing the free cash flow with its dividends, you can see whether a company has sufficient cash to pay dividends.  

Net cash from operation - CAPEX =  Free Cash Flow

You want to see the free cash flow being the bigger number more often than not.

When dividend is the larger number compared to the free cash flow, this may occur when a company is putting cash to good use (capex).  When dividend  is the larger number is fine on occasional years.  Prolonged periods of insufficient free cash flow will often lead to dividends being cut or scrapped eventually.

When analysing a company, it is often a good idea to compare free cash flow with the dividends over a period of ten years.

FCF dividend cover

A quick way to check whether cash flow is sufficient to pay dividends is by using the free cash flow dividend cover ratio.   This is calculated as follows:

Free Cash Flow dividend cover =  Free cash flow / dividends.

When free cash flow exceeds the dividends by a big margin, it can be a sign that the company may be capable of paying a much bigger dividend in the future.

Checking the Safety of Dividend Payments using Free Cash Flow Dividend Cover

A quick way to check whether cash flow is sufficient to pay dividends is by using the free cash flow dividend cover ratio.

This is calculated as follows:

Free cash flow dividend cover 
=  free cash flow per share / dividend per share

If free cash flow is sufficient to pay dividends then the ratio will be more than 1.

It is a goo idea to compare free cash flow per share with dividends per share over a period of 10 years.



Interpreting free cash flow dividend cover

1.  A great business generates consistent and growing free cash flows.

2.  During a company's period of heavy investment, the free cash flow may not cover its dividend.

3.  Usually, this maybe for that period and its free cash flow will soon be more than sufficient to cover dividends.

4.  When free cash flow per share exceeds the dividend per share by a big margin, it can be a sign that the company may be capable of paying a much bigger dividend in the future.

Beware the "yield trap".

Understandably, income investors study dividend yields quite closely. After all, a share on a dividend yield of 5% will pay out twice as much as a share rated on a more miserly yield of 2.5%.

Some investors look at historic yields; some at forecast (or "prospective") yields. It's not a deal-breaker either way, although personally I prefer forecast yields.

But here's the kicker: either way, those yields can be unexploded mines, lurking for the unwary. Looking at yield on its own, in short, can quickly introduce you -- painfully -- to the meaning of the term "yield trap".

Siren call

The yield trap is simply explained. You buy a share, attracted by the high yield. But the dividend is then cut, or cancelled -- leaving you without the anticipated income. Worse, unsupported by the payout, the share price usually falls as well, leaving you also nursing a capital loss.

Let's see it in action.

Company A pays out 9 pence a share, with shares changing hands for 100 pence per share. So the dividend yield -- which is the dividend per share, divided by the share price, and multiplied by a hundred to turn it into a percentage -- is 9%.

But that 9 pence is unsustainable. Company A then halves its dividend, slashing investors' income. What happens to the yield? If the share drops to -- say -- 80 pence, the historic yield the becomes 5.6%. The "yield on cost" figure, of course, is 4.5%.

Dividend cover

How, then, should investors spot potential yield traps? The most obvious reason for slashing the dividend is that the business simply hasn't got the money to pay it.

The business's earnings, in short, aren't large enough to support a distribution to shareholders at historic levels.

Put another way, actual earnings per share aren't sufficiently when large compared to the anticipated dividend per share.

Which is where the notion of 'dividend cover' comes in: earnings per share divided by dividend per share.

Interpret with care

Now, dividend cover shouldn't be followed blindly. 

• Some businesses -- such as utilities, for instance -- can quite happily operate with lower levels of dividend cover than more cyclical businesses. 
• Other businesses -- such as REITs -- must pay out a fixed proportion of earnings as dividends, so again a low level of dividend cover is the norm.
• Still other businesses have very high levels of dividend cover, because they are growing -- and therefore retaining earnings for future investment -- rather than paying them out as dividends.

But as a broad brush generalisation, 

• a ratio of close to one is definitely the danger zone. 
• A ratio much bigger than two indicates a certain parsimony. 
• Personally speaking, a ratio of 1.5-2.5 is usually what I'm looking for.

5 Shares At Risk Of A Dividend Cut

Danger signs

The table below highlights five shares with dividend cover well into the danger zone that I've mentioned. They're all big names, and -- given their yields -- are popular with income investors. And in each case, I've shown the last full year's earnings per share and dividend, yield and dividend cover.

There are shares with lower levels of dividend cover, to be sure -- but they tend to be REITs, or other special cases. The five highlighted have fewer extenuating circumstances, and seem to me to be more in danger of reducing their payout.

Company	Forecast yield %	Full-year earnings per share	Dividend	Dividend cover
Standard Life (LSE: SL)	6.6%	13p	13.8p	0.9
United Utilities (LSE: UU)	5.3%	35.3p	32.1p	1.1
Hargreaves Lansdown (LSE: HL)	4.7%	20.3p	18.9p	1.1
Admiral (LSE: ADM)	7.7%	81.9p	75.6p	1.1
Aviva (LSE: AV)	10.1%	5.8p	26p	0.2

So should holders of these shares be worried? There isn't sadly, a clear-cut answer -- a fact that highlights the importance of looking at the underlying data quite carefully, and considering the full set of circumstances.

Reading the runes

Standard Life, for instance, seems clear-cut, on both a historic and forecast basis: by my reckoning, the dividend is genuinely sailing close to the wind.

But Hargreaves Lansdown and Admiral, though, complicate matters by distinguishing between an ordinary dividend and a more discretionary extra 'special' dividend. But either way, a cut is a cut, and both firms have a level of dividend cover just above one, implying that there's very little margin of safety.

United Utilities may surprise you, depending on which stock screener you use. I've gone back to the annual accounts, and used the underlying earnings per share of 35.3p, described by the company as "providing a more representative view of business performance" -- implying the level of dividend cover that I've shown. Plug the statutory basic earnings per share of 45.7p into the calculation, though, and the dividend cover is a healthier 1.4.

And finally, there's Aviva, where the opposite problem applies. On a statutory basis, the earnings per share of 5.8p delivers a disturbing level of dividend cover of 0.2. Throw in the company's own preferred definition of earnings per share, and a healthier level of earnings of 53.8p emerges, giving a dividend cover of almost 2.

3 Investing Traps -- And How To Avoid Them

These tips should help you sidestep some common accounting pitfalls.

Alcoholics have 12 steps. Grievers have five stages. Investors have their phases, too, with the biggest leap coming when a fledgling shareholder begins tossing accounting ratios around. I've calculated ratios for years myself, both as a hedge-fund analyst and in making share recommendations for The Motley Fool, and I'll say this: ratios are both powerful and open to misuse by novices. I'd like to share a few tricks with you to help you avoid some common pitfalls.

Trap 1: Focusing too much on return on equity (ROE)

The much-vaunted ROE seems pure: take net profits, divide by shareholders' equity, and you see how efficient a business is with investors' money. ROE is Warren Buffet's favourite ratio, and executive pay is sometimes tied to it.

When it's a trap: When it's enhanced by debt. Borrowing funds to make more money for shareholders isn't necessarily evil, and is sometimes beneficial. But investors strictly watching ROE will miss the additional risk taken by a management team 'gearing up' to meet performance targets.

Protect yourself: Add return on invested capital (ROIC) to your arsenal. Using the same principle as ROE, ROIC essentially compares after-tax operating profits to both debt and equity capital, and thus provides a better measure of operational success that can't be inflated by a financing decision. Moreover, research by American equity strategist Michael Mauboussin of Legg Mason shows that companies whose ROICs either rise or remain consistently high tend to outperform others. Search online to find the precise formula, or drop me a comment in the box below.

Using Standard & Poor's Capital IQ database, I screened for companies with returns on capital (a near-identical cousin of ROIC) above 20% that have seen an improvement in return on capital during the past five years. These shares are not recommendations, but rather screen results that may be of interest given the discussion.

Company	Market cap (£m)	Return on capital
		Last fiscal year	Five years ago
Croda International (LSE: CRDA)	2,638	26.3%	22.8%
Renishaw (LSE: RSW)	1,053	25.1%	16.9%
Burberry (LSE: BRBY)	6,172	24.4%	20.0%

Trap 2: Taking turnover growth at face value

A sale is a sale, right? Wrong. Turnover is a prime line for accounts manipulation.

When it's a trap: Intricate shenanigans with turnover figures can be tough to uncover, but a simple rule of thumb is to become suspicious if growth in trade receivables (for instance, the amounts customers owe) meaningfully exceeds growth in revenues. This could indicate 'channel stuffing', whereby a company extends overly generous terms to customers simply to gain a short-term turnover boost.

Protect yourself: Using a screening tool or your own sums, compute the relative growth of both sales and trade receivables, particularly for companies whose growing turnover forms a major part of your investing thesis.

Again using Capital IQ, I noticed retailer Dunelm (LSE: DNLM) reported attractive 9% growth in sales last year (especially in this consumer market) -- albeit accompanied by a troubling 22% increase in trade receivables. While not a red flag outright, it's something to investigate further.

Trap 3: Using accounting profits to compute dividend cover

I've done this myself, and feel it's probably acceptable with stable companies clearly able to pay shareholders.

When it's a trap: The first thing a budding investor learns is that for accounting reasons, profits don't always match cash flow -- from which dividends are paid. Though cash flows and profits should theoretically match over time, profits are skewed by 'accrual' calculations, such as spreading the cost of equipment purchases over the life of the equipment, versus charging the costs in the year they occurred.

Protect yourself: Experienced analysts use free cash flow instead of reported earnings to produce a more reliable measure of dividend safety. Read this old-school Fool article for a moredetailed discussion on free cash flow. Swapping cash flow for accounting profits in your dividend cover calculation should increase its reliability.

Capital IQ turned up these companies as having cash flows materially exceeding accounting profits.

Company	Net profits (£m)	Free cash flow (£m)
Marks & Spencer (LSE: MKS)	603	701
Sage Group (LSE: SGE)	189	283
Rexam (LSE: REX)	154	265

There you have it. You're now three traps wiser, which is a step ahead of most investors. Indeed, while spotting numerical chicanery may be best for sidestepping share-price stinkers, avoiding losers is more than half the battle to building a winning portfolio.

http://www.fool.co.uk/news/investing/2012/02/02/3-investing-traps-and-how-to-avoid-them.aspx?source=ufwflwlnk0000001

Calculate investor ratios

Investor ratios are used by existing and potential investors of mostly publicly listed companies.  They can be obtained or calculated where necessary from publicly available information.


EARNINGS PER SHARE (EPS)

This is a popular profitability statistic used by financial analysts.  'Earnings available for distribution' is bottom-line net profit attributable to shareholders after all other costs have been deducted.  Many remuneration packages are linked to EPS growth.

EPS = Earnings available for distribution /  Number of shares in issue



PRICE/EARNINGS (P/E) RATIO

The P/E ratio applies to publicly listed companies and is a key measure of value for investors.  A P/E ratio of 10 means that investors are willing to pay 10 times previous year's earnings for each share.  Generally, the higher the P/E ratio, the higher the growth prospects perceived by investors.

P/E ratio =  Share price / EPS



DIVIDEND YIELD

This measures cash paid to shareholders as dividends.  This should be compared to capital growth, to measure the overall return to shareholders.

Dividend yield = Dividend per share / Price per share

Mature businesses tend to have higher dividend yields than young businesses, as the latter reinvest most of their earnings.  Investors looking for high-income investments choose high-dividend yield companies.



DIVIDEND COVER

This follows a similar principle to 'interest cover'.  It measures how many times a business can pay its dividends from its earnings.  It is used as a measure of dividend risk.

Dividend cover = EPS / Dividend per share

It also measure the proportion of profits retained in a business versus paid out as dividends.  For example, a dividend cover 3 times shows that a business has paid one third of its profits to shareholders and retained two-thirds.  Retained earnings are an important source of finance and therefore dividend cover is often high.

Use investor ratios to see if business goals are aligned with investor goals.


Related posts:

Measuring Business Performance

Measure Profitability

Measure short-term solvency and liquidity

Measure long-term solvency and stability

Calculate investor ratios

Evaluate a business using ratios

Estimate the value of a business

Which shares for income?

Which shares for income?
The yield on BT of 19pc sounds good, but remember the adage "if it looks too good to be true, it probably is.

By Gavin Oldham
Published: 3:32PM BST 09 Apr 2009

With the equity market close to a six-year low and with equity yields at historically high levels compared with gilts, the temptation is there for investors to switch into shares: not only in the hunt for income but also factoring in that one day the equity market will recover.

The challenge is, however, to find those rewards without shouldering too much risk; because whereas cash savings can face risk of default, it is in equities that you face investment risk.


Related Articles
Dividend reprieve as dozens of FTSE companies increase payouts by 10pc
Other inflation hedges
Is silver the new gold?
US fund manager declares war on UK trackers
Inflation: how to protect your portfolio
Deflation: how to protect your portfolio



However, it is also worth remembering that since 1900 high-yielding shares have outperformed the stock market as a whole, 85pc of the time over 10-year periods. They've also outperformed the market since September 2008, when the markets really went into freefall.

As an example of the relationship between risk and yield, let's compare two blue chips with apparent dividend attractions: BP and BT.

This week, the yield on BT is 19pc net of basic-rate tax. Sounds good, but remember the adage "if it looks too good to be true, it probably is". Every analyst in the City expects BT to cut its dividend next time around. Investors should be cautious of above-average share yields: the market is telling you "the higher the yield the higher the risk".

BP has a yield of 9pc. Recently, there has been speculation that the low oil price may force the company to cut the dividend. This has proved unfounded, as BP's management has said the dividend will be maintained this year and it will try to maintain it into 2010, even if the oil price stays at current levels. So here we have some medium-term visibility and potential for capital growth if the oil price rises over the medium term.

When considering an investment for yield, note the dividend cover; this is how many times the profits cover the dividend and is an indicator of whether a company will be able to pay future dividends at the current rate or higher. It is calculated by dividing the net earnings per share by the net dividend per share.

Dividend cover = EPS / DPS

or

Dividend cover = 1 / DPO

For example, if a company has earnings per share of 5p and it pays out a dividend of 2.5p, the dividend cover will be 5/2.5 = 2. The higher the cover, the better the chance of maintaining the dividend if profits fall. However, a lower figure may be acceptable if the group's profits are relatively stable.

So a good portfolio of equity income shares would feature mainstream companies with good dividend cover and a relatively recession-proof business (such as energy), plus a good helping of the FTSE 100 iShare – a form of exchange traded fund (ETF) marketed by Barclays – to provide some extra diversification, and to provide the opportunity to take advantage of market volatility.

Such a portfolio might include BP, yielding 9pc with 2.6 times dividend cover; GlaxoSmithKline, yielding 5.5pc with 1.6 times cover; National Grid, yielding 6.5pc with 2 times cover; Scottish & Southern, yielding 5.7pc (1.7); Shell, yielding 4.2pc (3.5); Vodafone, yielding 6pc (1.8) plus the FTSE iShare yielding 5.1pc with no cover calculation available.

An investment of £12,000 could therefore give you about £710 income over a full year, an overall yield of 5.9pc.

These equity shares could provide a relatively stable source of income combined with the potential for capital growth. There is, of course, a risk of further setbacks in the markets that could take your investment value lower, but with blue-chip companies like these it's a relatively low-risk portfolio as equities go.

Keep in touch with the companies you've invested in: if you hold the shares in an Isa or a broker's nominee, opt in for shareholder communications direct from the company. It's your right to be kept informed and it shouldn't cost you extra.

Your holding in the FTSE 100 iShare may provide the opportunity to do some tactical purchases or sales. Rather than buying the whole holding at once, you could invest in £1,000 steps as the market falls back, then set a limit at, say, 10pc up on your purchase price to sell as the market strengthens.

This way you can take advantage of short-term volatility to improve the return on the portfolio as a whole. Finally, if you're a taxpayer make sure you use your Isa allowance to minimise your income tax bill.

Gavin Oldham is chief executive of the Share Centre


http://www.telegraph.co.uk/finance/personalfinance/investing/5131421/Which-shares-for-income.html

Dividends: Which are safe and which may fall?

Dividends: Which are safe and which may fall?

Key: Dividend cover = Earnings / Dividend

The income from shares offers some protection against a bear market – unless it is cut. We asked the experts which companies looked safest.

By Richard Evans
Published: 6:57AM GMT 05 Mar 2009

Share prices have been falling for months now but for many investors there has been one crumb of comfort: dividends.

After all, share prices can recover if you don’t sell – and hanging on can be relatively painless if the income from your investment is maintained or even increased.


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But there have been some worrying developments for dividends recently. HSBC, the bank that seemed relatively unscathed by the financial crisis, was forced to cut its payout; now there are rumours that BP may have to freeze its dividend for the first time in years because of the falling oil price.

So we asked the experts which dividends they thought should be safe despite the turmoil – and which ones could be at risk.

Ian Lance, manager of the Schroder Income fund, said: "Despite all the concerns about the sustainability of dividend payments in the face of falling profits, we believe those invested in UK equities are still being well rewarded, particularly as yield is becoming increasingly difficult to find in many other areas of investment.

"The dividend yield on the highest yielding UK equities has risen to its highest point in around 20 years – even if you exclude financials. The dividend yield on non-financial stocks now exceeds the yield on 10-year government bonds."

As for concerns about how resilient these yields will be, Mr Lance said dividend levels were likely to fall across the UK market as a whole over the next couple of years, but he remained confident that a number of companies had sufficient dividend "cover" – the degree to which the dividend is exceeded by earnings – to support their current payouts even if earnings fell.

Schroders believes that the most resilient and attractive dividend streams will be among the long-established, well-diversified "mega caps" and companies that declare dividends in US dollars, given that sterling’s weakness pushes up their value. "These include names such as GlaxoSmithKline, AstraZeneca, Royal Dutch Shell and Vodafone, which we bought some time ago when they were out of favour with other investors and consequently undervalued, and which we continue to hold today," said Mr Lance.

Jonathan Jackson, an equity analyst at Killik & Co, the stockbroker, is not convinced that BP's dividend is under threat; he expects it to be safe for at least this year and next. "My reading is that BP will let gearing [borrowing relative to equity] increase," he said. "Holding the dollar-denominated dividend means 23pc growth for British shareholders, resulting in a yield of 10pc."

He also backs Vodafone, which is yielding 6.5pc, pointing to its strong balance sheet and "fairly defensive" qualities. "Tobacco stocks such as BAT and Imperial Tobacco have stable cash flows throughout the cycle," he added.

Hugh Duff, an investment manager at Scottish Investment Trust, said that among his holdings were two companies likely to maintain, or possibly grow, their dividends: Serco and De La Rue.

"Serco is a leading international services company operating in a broad range of sectors, servicing both private and public markets. The long-term nature of Serco’s contracts and the significant order book give us confidence in the company’s defensive and highly visible earnings growth," he said.

"De La Rue is the world’s largest commercial security printer and literally has a licence to print money. The company's main operation is the production of 150 currencies on behalf of central banks. The demand for currency printing is expected to continue to show stable growth, with a key driver being the increasing use of cash machines which require notes to be in mint condition. De La Rue has a very good track record of returning the profits from this business to shareholders through special dividends and dividends."

Turning to companies seen as candidates for cutting their dividends, Mr Jackson singled out BT Group. "There are trading difficulties in the global services division and a pension fund gap," he said. A recent ruling from the pensions regulator that pensions should take priority over dividends made a cut more likely, he added.

"The consensus in the City is that the dividend could be halved but we don’t know the size of the pensions deficit. BT used to put £280m into the fund annually to reduce the gap, now it could need to put in twice that figure. The cost of the dividend is £1.2bn."

Mark Hall, a fund manager at Rensburg Sheppards, voiced concern about life insurers. He said: "The sector I am most concerned about now regarding dividend payments is the life assurers such as Legal & General and Aviva. They have big bond portfolios and are vulnerable to any further dislocation in the financial system putting even greater pressure on their solvency ratios.

"This contrasts with the general insurance companies and Lloyd's specialists such as Royal Sun Alliance and Amlin, where we think the dividend prospects are really quite good."

http://www.telegraph.co.uk/finance/personalfinance/investing/4941355/Dividends-Which-are-safe-and-which-may-fall.html

Which shares for income?

Which shares for income?

The yield on BT of 19pc sounds good, but remember the adage "if it looks too good to be true, it probably is.

By Gavin Oldham
Last Updated: 6:47PM BST 10 Apr 2009

With the equity market close to a six-year low and with equity yields at historically high levels compared with gilts, the temptation is there for investors to switch into shares: not only in the hunt for income but also factoring in that one day the equity market will recover.

The challenge is, however, to find those rewards without shouldering too much risk; because whereas cash savings can face risk of default, it is in equities that you face investment risk.

Related Articles
Other inflation hedges
Is silver the new gold?
US fund manager declares war on UK trackers
Inflation: how to protect your portfolio
Deflation: How to protect your portfolio
Investors 'ready to return to stock market'

However, it is also worth remembering that since 1900 high-yielding shares have outperformed the stock market as a whole, 85pc of the time over 10-year periods. They've also outperformed the market since September 2008, when the markets really went into freefall.

As an example of the relationship between risk and yield, let's compare two blue chips with apparent dividend attractions: BP and BT.

This week, the yield on BT is 19pc net of basic-rate tax. Sounds good, but remember the adage "if it looks too good to be true, it probably is". Every analyst in the City expects BT to cut its dividend next time around. Investors should be cautious of above-average share yields: the market is telling you "the higher the yield the higher the risk".

BP has a yield of 9pc. Recently, there has been speculation that the low oil price may force the company to cut the dividend. This has proved unfounded, as BP's management has said the dividend will be maintained this year and it will try to maintain it into 2010, even if the oil price stays at current levels. So here we have some medium-term visibility and potential for capital growth if the oil price rises over the medium term.

When considering an investment for yield, note the dividend cover; this is how many times the profits cover the dividend and is an indicator of whether a company will be able to pay future dividends at the current rate or higher. It is calculated by dividing the net earnings per share by the net dividend per share.

For example, if a company has earnings per share of 5p and it pays out a dividend of 2.5p, the dividend cover will be 5/2.5 = 2. The higher the cover, the better the chance of maintaining the dividend if profits fall. However, a lower figure may be acceptable if the group's profits are relatively stable.

So a good portfolio of equity income shares would feature mainstream companies with good dividend cover and a relatively recession-proof business (such as energy), plus a good helping of the FTSE 100 iShare – a form of exchange traded fund (ETF) marketed by Barclays – to provide some extra diversification, and to provide the opportunity to take advantage of market volatility.

Such a portfolio might include BP, yielding 9pc with 2.6 times dividend cover; GlaxoSmithKline, yielding 5.5pc with 1.6 times cover; National Grid, yielding 6.5pc with 2 times cover; Scottish & Southern, yielding 5.7pc (1.7); Shell, yielding 4.2pc (3.5); Vodafone, yielding 6pc (1.8) plus the FTSE iShare yielding 5.1pc with no cover calculation available.

An investment of £12,000 could therefore give you about £710 income over a full year, an overall yield of 5.9pc.

These equity shares could provide a relatively stable source of income combined with the potential for capital growth. There is, of course, a risk of further setbacks in the markets that could take your investment value lower, but with blue-chip companies like these it's a relatively low-risk portfolio as equities go.

Keep in touch with the companies you've invested in: if you hold the shares in an Isa or a broker's nominee, opt in for shareholder communications direct from the company. It's your right to be kept informed and it shouldn't cost you extra.

Your holding in the FTSE 100 iShare may provide the opportunity to do some tactical purchases or sales. Rather than buying the whole holding at once, you could invest in £1,000 steps as the market falls back, then set a limit at, say, 10pc up on your purchase price to sell as the market strengthens.

This way you can take advantage of short-term volatility to improve the return on the portfolio as a whole. Finally, if you're a taxpayer make sure you use your Isa allowance to minimise your income tax bill.

Gavin Oldham is chief executive of the Share Centre

http://www.telegraph.co.uk/finance/personalfinance/investing/5131421/Which-shares-for-income.html

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

http://www.telegraph.co.uk/finance/personalfinance/investing/shares/4537565/Investing-for-income-Where-savers-can-escape-zero-interest-rates.html