When comparing company dividends, you need to do more than simply look at today’s headline yield. In these uncertain times, with a number of big-name FTSE 100 companies slashing their payouts over the last year, you need to see how well that dividend is covered, to work out how sustainable the payout is likely to be.
Dividend flow
You also need to check whether the company has a track record of progressively increasing its dividend year after year, and is generating enough cash to do so in the future. In some cases, management may help by publicly stating by how much they plan to increase their dividend for the next few years. As ever with dividends, nothing is guaranteed, but this can be a handy indication of what to expect.
Utility stock Pennon Group (LSE: PNN), owners of South West Water, is one such company. On 1 April it paid out interim dividend of 10.46p per share, which represents a whopping 4.8% increase on the previous year. This follows its previously announced policy to grow the group’s dividend by 4% above RPI inflation per annum to 2020. RPI stood at 0.8% last September.
High and rising
A high dividend is nice, but a rising dividend is even nicer. Currently, Pennon currently yields a decent but hardly to-die-for 3.91%, which means it may have slipped under the radar for many income seekers. But given that generous growth rate, it may be time to redirect your searchlights. RPI hit 1.3% in April, which would have taken the dividend hike to 5.3%.
Let’s say that Pennon increases its dividend by 5.3% a year for each of the next four years. This would lift the yield to 4.81%, assuming all other things being equal (which of course they won’t be). My admittedly daft calculation does at least reveal the power of aggressive dividend progression.
Drugs don’t always work
You won’t enjoy that kind of progression with a pharmaceutical stock GlaxoSmithKline (LSE: GSK). In May last year, it guaranteed its dividend for three years, maintaining dividends at 80p a share until 2017. That means no progression at all for at least the next couple of years. Investors weren’t complaining, however, because the alternative was worse.
Most were simply relieved that Glaxo felt strong enough to make such a pledge, given plunging revenues from key asthma treatment Advair, threatened from generics. Still, with the stock yielding 5.50%, the money would be put to better use investing in the company’s vital drugs pipeline. So no complaints from me.
Tinto blank-out
Don’t be misled by the supposed yield of 7.40% on offer at mining giant Rio Tinto (LSE: RIO). The 2016 dividend is heading for a fall, as the rapid decline in commodity prices forced boss Sam Walsh to backtrack on his pledge to turn the stock into an income machine. With underlying profit plummeting from $9.3bn to $4.5bn last year, his policy was no longer sustainable, and the inevitable cut was duly announced in February.
Right now, Rio Tinto trades on a forward yield of just 3.5% for December 2017. Pennon Group is already offering more than that, with plenty of progression in sight, whereas Rio Tinto faces a lengthy restructuring and revival job before its dividend can recapture former glories, if it ever does. For forward-minded dividend seekers, Pennon is now the one to watch.
