Can we really trust today’s high-yielding dividend stocks?

The FTSE 100 is packed full of top dividend stocks offering massive yields. Does this offer a sustainable passive income or could these payouts be cut?

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Bearded man writing on notepad in front of computer

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Anybody who loves top dividend stocks will struggle to resist going on a buying spree at the moment. The FTSE 100 is packed full of them.

Some of the yields on offer are astonishing. Housebuilder Persimmon currently yields 17.9%. That’s the best on the FTSE 100 but mining giant Rio Tinto isn’t that far behind, with a yield of 12.87%.

Fund manager Abrdn yields 9.37%, insurer Phoenix Group Holdings yields 9.07%, and builder Taylor Wimpey yields 9.05%. Wow.

I’m buying dividend stocks today

There are plenty more where those came from. In fact, I can hardly remember a time when yields were so high. But can I trust them?

A yield is calculated by dividing a company’s dividend by its share price. So if the dividend is 5p and the share trades at £1, the yield is 5%. This means that if the share price halves, say, to 50p, the yield doubles to 10%. 

As this basic example shows, a high yield is often the sign of a company in trouble. It signals both an opportunity, and a threat.

If stock markets are down generally and my chosen dividend stock has got caught up in the wider malaise, then I’ll see that as an opportunity. Loads of stocks fits the bill right now, thanks to this year’s global political and economic turmoil. 

But I would also work through its reports, statements, and updates, to see whether there are problems specific to that company. In particular, I would look to see whether management can afford to continue paying its dividend. The easiest way of doing this is to check dividend cover. This is calculated by dividing shareholder payouts by company earnings, but it can also be found easily online. 

Ideally, it will be covered twice or more. This figure is often lower with utilities, where earnings are typically more reliable, allowing companies to hand more of them to shareholders. A healthy level of cover is no guarantee, but it’s a promising sign that the company will be able to continue paying me passive income in future.

I would also look at other company numbers, such as the size of its net debt and of course the reliability of its free cash flows, which fund shareholder payouts. Similarly, I would prioritise firms with a lengthy track record of making dividend payments. Especially those who maintained them through thick and thin (and the pandemic, too). 

FTSE 100 offers amazing yields

Any company that increases its dividends year after year would be high on my list, as this gives me a rising passive income. While past performance is no guide to the future, it does offer reassurance.

As a general rule, I would prefer a company with a lower dividend that looks more reliable, than a higher dividend that is likely to be cut. When a dividend is cut for being unaffordable, the company’s share price tends to bleed, too.

Naturally, a host of other factors will determine whether the dividend is sustainable. A strong balance sheet, loyal customer base, unique brand, or popular products can all help secure those all-important cash flows. 

While I’m thrilled by all the top FTSE 100 dividend stocks out there right now, I’m doing some careful sums before buying them.

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.

Harvey Jones holds shares in Persimmon. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

View of Tower Bridge in Autumn
Investing Articles

Why wait? I’d buy FTSE 100 shares now before the next stock market rally!

Our writer explains why he'd snap up what he sees as bargain FTSE 100 shares now rather than waiting in…

Read more »

Investing Articles

Is it time for me to change my tune about Rolls-Royce shares?

This Fool has steered clear of buying Rolls-Royce shares. But after its recent performance, he's reconsidering his stance. Here's why.

Read more »

Investing Articles

Aviva share price: 3 reasons to consider buying for 2024

The Aviva share price is still lower then when I bought some nearly a decade ago. Here's why I'm thinking…

Read more »

Front view photo of a woman using digital tablet in London
Investing Articles

These 2 shares could bank me £328 a month in second income

Jon Smith runs through two FTSE stocks that have above-average dividend yields that could pay out a generous second income…

Read more »

Stack of one pound coins falling over
Investing Articles

This passive income plan is simple – but could earn me thousands!

Christopher Ruane explains how putting a fiver a day to work in the stock market might help him earn thousands…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on

After record profits, are Lloyds shares a buy, sell, or hold?

As Lloyds pulls in pre-tax profits of £7.5bn, boosts its dividend, and continues to repurchase shares, are the company’s shares…

Read more »

Investing Articles

NatWest shares: is a once-in-a-lifetime opportunity on the way?

Should investors get ready for a unique opportunity as the UK government plans to sell off its NatWest shares later…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

3 charts that indicate this FTSE 100 stock is a once-in-a-decade passive income opportunity

The dividend yield on Unilever shares is at a 10-year high. And Stephen Wright also sees positive signs for the…

Read more »