Recent stock market volatility has driven the dividend yields on many UK shares through the roof. The FTSE 100 average yield has leapt to 3.8% in recent days. And it could continue to rise as investor jitters threaten to push share prices still lower.
But, of course, sensible dividend investing involves more than just looking at yields. These readings are based merely on City forecasts. And in my opinion, a lot of FTSE index dividend projections are looking stretched.
Many balance sheets are loaded with debt following the Covid-19 crisis. What’s more, earnings at many blue-chip companies are in danger of disappointing as inflationary pressures persist and central banks hike rates.
I have no such worries about dividend forecasts at BAE Systems (LSE:BA.) however. In fact, I think the firm could be one of the best FTSE 100 stocks to buy for dividend growth.
Robust demand
This is thanks to the company’s non-cyclical operations that help earnings remain stable, regardless of economic conditions. In fact, the company’s profits outlook is stronger now than it’s been for decades as tense geopolitical conditions boost defence spending.
This month, the US, UK and Australia signed the AUKUS nuclear submarine pact. The $368m programme will see the Australian navy acquire a fleet of underwater craft over the next 30 years.
AUKUS reflects growing fears in the West of Chinese expansionism in the South China Sea. And submarine expert BAE Systems is set to play an important role in the delivery of the vessels.
But the FTSE firm is about much more than sea power and it enjoyed record order intake of £37.1bn in 2022. Russia’s invasion of Ukraine and the ongoing fight against terrorism means demand across its wide range of technologies is rising strongly.
Dividend growth
With this in mind, City brokers expect earnings and dividends at BAE Systems to keep growing over the next few years, at least.
An improved annual payout of 28.7p per share is predicted for this year, resulting in a decent 3.2% dividend yield. And for 2024 and 2025, dividends of 31p and 33p respectively are expected.
Consequently, BAE Systems’ yield rises to 3.4% and 3.6% for these years.
Encouragingly, these projections are well covered by anticipated earnings too. Dividend coverage of 2 times and above provides a decent margin of error for investors. And at BAE Systems estimated dividends are covered between 2 times and 2.1 times over the next three years.
The defence business also has significant balance sheet strength to help it pay those expected dividends if earnings disappoint. Its net debt to EBITDA ratio sat at just 1.2 times as of the end of 2022.
A top FTSE buy
There’s no such thing as a risk-free stock. And dividends at BAE Systems could come in lower than forecast if, for example, project delivery encounters problems, or it fails to win key contracts.
Yet, on balance, I believe the company is in great shape to grow dividends in the coming years. In fact, I think it could be one of the best FTSE 100 stocks for long-term passive income.
