With the stock market suffering a significant downturn last year, the dividend yields of many leading UK businesses have seen a notable increase. And for new investors looking to get started on their wealth-building journey, this has created some lucrative income opportunities.
The FTSE 100 as a whole has recovered from last year’s volatility. Subsequently, since higher stock prices drag yields down, its average shareholder payout now stands at around 3.53%. But there are some companies within the UK’s flagship index offering substantially more.
Big yields
Looking at the index, several businesses offer dividend yields beyond 6%, or even 7%. Persimmon, the homebuilder, is currently offering a massive payout of 17.1%! Seems like the perfect addition to an investment portfolio, right? Sadly, it’s not that simple.
It’s important to realise that dividends are completely optional payments for businesses. It’s a method of returning excess capital to shareholders that a firm has no better use for. But the key word there is ‘excess’. All too often, high-dividend-yield stocks look like they offer an impressive payout only to later announce dividends are being cut, or even outright cancelled.
In the case of Persimmon, the enormous yield stems from its share price tanking by almost 50% in the last 12 months. Thanks to rising interest rates, the housing market is slowing. And property values are already starting to fall, making the outlook for this business look fairly bleak. At least in the short term.
In the long run, it may prove to be a solid investment. After all, it’s no secret the UK is short on housing. But investors expecting the 17.1% dividend yield to be sustainable will likely be left disappointed.
Investing for sustainable income
For a company to sustain and grow shareholder payouts, it needs reliable cash flow generation. And that’s something DS Smith (LSE:SMDS) seems to have in spades.
As a reminder, the group is one of Europe’s largest cardboard manufacturers – exciting, I know. But with the rising popularity of e-commerce, demand for suitable packaging and shipping materials has been surging over the last decade.
As online consumer spending has slowed courtesy of inflation, investors have been less optimistic about the near-term demand for its products. And the stock price is down nearly 10% over the past year to reflect that. Looking at its latest results, it seems this hunch was correct. Packaging volume declined by roughly 3%. And yet revenue and pre-tax profits are up by 28% and 80% respectively!
A 3% drop isn’t nothing. And it could get worse if the UK falls into a steep recession, as some economists fear. However, management has so far been able to offset the demand in volume, and then some, through price hikes. So much so that dividends per share just got a 25% boost, putting the shareholder yield firmly ahead of the FTSE 100 average at 4.7%.
Pairing increasing payouts with a discounted valuation is a proven recipe for long-term success in the stock market. And while it’s far from a risk-free investment, investing £500 in DS Smith would likely be my first move if I were starting my income portfolio from scratch today.
