Dividends are the lifeblood of stock market investing. They create an incentive to buy and make wealth generation much swifter through the power of compounding.
Two UK-listed equities with enticing dividend yields are FTSE 100 insurance company Aviva (LSE:AV) and management software provider Micro Focus International (LSE:MCRO).
High yield insurer
Aviva was founded 20 years ago when two British insurers merged. It specialises in general insurance, life assurance, and pensions.
The insurer has a £15bn market cap, a price-to-earnings ratio (P/E) of 7, and earnings per share of 58p. Its highly attractive dividend yield is over 7%.
Billionaire investor Warren Buffett loves insurance companies, and I think he’d be a fan of Aviva. Over the years, it’s kept up its strong and increasing dividend payouts and ranks number one in UK workplace pensions. Serving 33m customers and with over 30,000 employees, it’s both well established and trusted.
I think its low P/E results from an extended streamlining strategy that’s forecast to take four years to complete. The aim of this is to reduce debt and sustain its progressive dividend.
Brexit also remains a risk factor, as an economic downturn could have an adverse effect on the insurer.
Skyrocketing dividend alert!
Micro Focus International has a £2.6bn market cap and earnings per share are £3.88. Today MCRO has a whopping dividend yield of 11.5% and its P/E is only 2. So, should this be celebrated or signal alarm bells?
The MCRO share price has fallen over 57% in the past year and nearly 29% year to date.
It has experienced cash flow troubles and earlier this month announced a decline in full-year profit and sales, along with the departure of its chair after a challenging year.
Revenue fell 7.3% to $3.35bn for the year to the end of October 2019.
The company took over Hewlett Packard Enterprise (HPE) software back in 2017 and has since confirmed that this has created many more complexities and hurdles for the business than expected.
Although this massive dividend yield may well be enticing, it comes with risk. Company policy is that it must be two-times covered by the adjusted earnings of the group. So, if cash flow and revenue problems continue, then I think the dividend may be under threat of a cut.
Going forward, the company is heavily invested in improving, to the tune of $70–$80m per year in 2020 and 2021, but doesn’t expect to benefit from these investments until later. For this reason, I’d avoid this share for now.
Higher may not mean better
Traditionally dividend yields were used by well-established companies, with limited future growth prospects, to entice and retain shareholders. This is still the case, but companies with high growth potential have also been known to dish out dividends if they’ve achieved a level of success and want to share that with investors.
Occasionally a company will increase its dividend yield to deflect attention from underlying problems and ongoing concerns. That doesn’t mean that a very low dividend yield means a bad investment. Perhaps the company is still in a period of growth and can’t afford to give too much back to shareholders.
With so much global uncertainty going on in the world, these are troubling times for investors. That said, I think Aviva is a safer investment than many others in the FTSE 100 and I think its attractive dividend and low P/E make it a nice income buy.
