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Here’s why smart investors are ignoring these big dividends

Public Domain.

On the face of it aerospace and defence technology firm Cobham (LSE: COB) looks like an appealing investment. The FTSE 250 company’s shares are currently changing hands at a 35% discount to a year ago, leaving them on a reasonable P/E rating of 14. But the main attraction is the chunky dividend, which at current levels yields an impressive 4.8% for the current year to the end of December.

But, of course, looks can be deceiving.

Profit warning

Last month, the Dorset-based firm issued a profit warning, saying that it now anticipates that group trading profit for 2016 will be in the range £255m to £275m, well below the previous consensus forecast of £291m, and potentially 23% lower than the £332m it made in 2015. The company has attributed the lowered profits guidance to softer trading conditions in its wireless and satellite communications markets.

But this isn’t the first time Cobham has cut its profits estimates this year. Back in April, shares in the aerospace and defence technology group fell sharply after it proposed a £500m rights issue following a big fall in trading profit for the first quarter of the year. The company revealed that trading profit had sunk to just £15m from the £50m reported for the same period in 2015, as a result of operational issues in the Wireless business leading to delayed shipments and a one-off charge of £9m.

Dividend cut

So should investors take advantage of the battered share price and grab those healthy-looking dividends? Well, not from where I’m sitting.

When it comes to dividends Cobham actually has a pretty decent record. Since 2005 the company has increased its payouts each year, with very healthy dividend coverage. But 2016 will be very different. After announcing very disappointing half-year results in August, management took the brave decision to cut the interim dividend for the first time in ten years from 2.585p to 2.03p per share.

I would certainly want to wait until there are signs of a turnaround before building a stake in Cobham, as I fear further dividend cuts may be necessary as the company treads the difficult road to recovery. I feel there are plenty more income stocks out there which carry much less risk.

Erratic behaviour

Another mid-cap company that currently supports a healthy-looking dividend yield is engineering firm Vesuvius (LSE: VSVS). Is it just me, or does that sound like a brand of mineral water, or maybe a volcano in Italy? Either way it’s a fantastic name for a company that specialises in molten metal flow engineering. In its most recent trading update the company said trading so far this year had remained in line with expectations as cost saving measures and foreign exchange benefits had offset a weak steel market.

The London-based engineer said that end markets had remained subdued and the company expects this to continue for the rest of the year. Despite the weak steel market, Vesuvius’ shares have performed well in recent months, gaining 15% since May, and still support a prospective dividend yield of 4.1%.

So why am I hesitant about its income potential? Frankly I don’t like the dividend history, with payouts increasing and decreasing erratically over the last 10 years, reflecting the volatile nature of the company’s earnings. Call me boring, but I like to see consistent earnings growth with steady rising dividend payouts.

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Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.