Aberdeen Asset Management plc (7.2%), Interserve plc (5.8%) & Legal & General Group Plc (5.7%): Should You Be Tempted By These Yields?

How safe are the dividends from Aberdeen Asset Management plc (LON:ADN), Interserve plc (LON:IRV) and Legal & General Group Plc (LON:LGEN)?

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Today, we’re going to look at three stocks offering yields of 5% or more.

Falling share price

Dividend investors shouldn’t base their investing decisions solely on high dividend yields. That’s because, unless the company cuts its dividend, whenever its share price falls, the yield rises. So, the steeper the share price falls, the faster the dividend yield rises.

Shares in Aberdeen Asset Management (LSE: ADN) yield 7.2% only because there’s been a 46% fall in its share price over the past 52 weeks. Weak investor sentiment towards emerging market assets is largely to blame for this, as investors have sought to reduce exposure to Asia and emerging markets equities which Aberdeen specialises in.

As assets under management decline, Aberdeen’s earnings potential falls too. Analysts expect that the company will see earnings fall 40% in this year, to 19.1p per share. This would mean its dividend cover would, for the first time, fall below the 1.0x level, which is generally regarded as the minimum level required for a sustainable dividend yield. And as earnings will no longer be enough to cover its dividends, Aberdeen’s 7.2% yield doesn’t look secure.

Fundamentals

Interserve (LSE: IRV) is one of Britain’s biggest public sector outsourcing companies, providing support services to a wide range of sectors, including healthcare, education, transport and defence. The company paid a total dividend of 24.3p per share in 2015, giving its shares an attractive yield of 5.8% at today’s levels. In addition, valuations look ridiculously cheap, with forward P/Es of 6.5 and 5.9, respectively.

Fundamentals for the sector are clearly in its favour, with the government keen to encourage more private sector involvement in the provision of public sector services, as it seeks to make operational saving and deliver “more for less”. Still, it hasn’t been all plain sailing for Interserve. Its shares are down 29% over the past year, as the company ended its £300m Leicester NHS cleaning and catering contract early, and as falling oil prices weakened the outlook for the group’s equipment services division.

What’s more, as a labour intensive business, cost pressures from the introduction of the new National Living Wage could see earnings hit over the next 12 months. City analysts seem to agree, with expectations that underlying earnings per share will fall 6% to 63.6p this year. But after an initial hit, earnings is set to recover in 2017, with forecasts that underlying EPS will grow by 11%, to 70.4p.

Dividends are forecast to grow by 4.1% to 25.3p per share this year, with a further rise of 4.7% to 26.5p per share in 2017. This means its shares trade at a prospective dividend yield of 6.0% — rising to 6.3% by the following year. The dividend looks secure, given that its expected underlying dividend cover will remain above 2.5x over the next two years.

In my view, the firm’s shares are a buy.

Earnings slump

Legal & General (LSE: LGEN) has raised its annual dividend payment over the past six consecutive years. And in those six years, dividends have grown by an average rate of 23%. Its most recent increases were 19% in 2015 and 21% in 2014, which indicates some slowing down.

But while dividend growth is slowing down, it should continue to outpace the FTSE 100 index. That’s because the company said future increases would grow in line with earnings and cash generation. City forecasts for the company are optimistic, with earnings per share set to grow 8% this year, and 7% in the following year. A high single digit dividend growth rate wouldn’t be all too bad given its current dividend yield – that’s 5.6% on a trailing twelve months (TTM)  basis, and 6.1% based on a prospective dividend of 14.3p per share in 2016.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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

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