When looking at the sorts of long-established, proven companies that make up much of the FTSE 100 index of leading shares, high dividend yields can often be rare. At the moment though, a number of FTSE 100 stocks offer dividends of 8%, 9%, or even 10%.
But when assessing what sort of shares might best suit my investment objectives, how could I choose from this embarrassment of (potential) riches?
Two 9%+ yielding blue-chip stocks
The first point I would make is that although some shares may suit my investment objectives better than others, I also always aim to maintain a diversified portfolio.
A couple of FTSE 100 stocks I already own would offer me a yield of over 9% if I bought them today. British American Tobacco (LSE: BATS) has a 9.4% yield, while Legal & General (LSE: LGEN) offers 9.5%.
But a yield on its own tells me nothing about how attractive a company might be for investment.
That is because dividends are never guaranteed. A company can always cut its dividend, meaning I will not end up earning the yield I hope for when I buy the shares.
While Legal & General has been raising its payout annually for many years, it cut its dividend during the 2008 financial crisis. By comparison, British American Tobacco has consistently increased its annual payout for several decades.
Future free cash flow potential
What about the future though? British American Tobacco generates massive free cash flows that can help to fund its generous quarterly dividend.
But I do have a couple of concerns. Cigarettes are declining in popularity in most markets. I am not yet convinced that the profit margins of alternative products will be high enough to mitigate the negative impact on earnings.
On top of that, servicing British American’s debt could eat into cash flows. Net debt has hovered close to £40bn in recent years. Rising interest rates could make that more costly to service.
Strong customer demand
As a financial group, Legal & General’s debt position is a bit harder to understand as it holds debt securities as part of its own investment portfolio. The average nominal value of its debt securities in the first half was £4.5bn.
Its market capitalisation is less than a quarter of the tobacco producer, admittedly. But I prefer the debt component of its balance sheet to British American’s.
Both companies have strong brands, large customer bases and juicy profit margins. I therefore think both could continue to throw off large free cash flows to help fund growing dividends in years to come.
Legal & General faces risks. A further economic crisis could lead to clients withdrawing funds and profits falling. But, unlike cigarettes, I expect demand in its core market of pensions to grow not decline for decades.
I’ve bought both
I have bought both of these FTSE 100 stocks this year so clearly I feel either can (hopefully) offer me an attractive long-term return.
But what if I only had enough spare money to add one of the duo to my ISA right now?
I’d plump for Legal & General. It has fallen 18% this year (and 15% over five years). I like its balance sheet more — and feel the long-term customer demand outlook carries fewer risks.
