When it comes to evaluating a stock based on the dividend yield, I need to be careful. If I filtered FTSE 250 stocks from highest to lowest yield, it doesn’t make sense to close my eyes and just buy the three highest ones. This might sound odd to some income investors, but hear me out.
Breaking the bank
To highlight my point, I’m going to start with the second highest yielding stock in the index, Close Brothers (LSE:CBG). The current yield is 20.87%, with the share price down 66% over the past year.
The business has been struggling over the past couple of years. It had to take on impairments relating to loans with Novitas, the lender it bought several years ago. It also has suffered from weak performance from Winterflood, the trading and investment arm of the bank.
From just looking at the dividend yield, income investors might think it’s worth a small investment. However, the business has suspended the dividend.
The dividend yield calculation takes into account the dividend per share from the past year, not the coming year ahead. Therefore, I expect the yield for the next year to sit firmly at 0%.
The top of the tree
The highest yielding stock in the entire FTSE 250 is the Diversified Energy Company (LSE:DEC). The oil and gas company has seen a similar fall in the share price, down 53% over the last year. This has helped to push the dividend yield up to 28.99%.
In contrast to some other exploration companies, the business is revenue generating, with the latest Q3 2023 results showing an adjusted EBITDA profit margin of 52%. This means that it can afford to pay out dividends due to the profitability.
However, the volatility in the share price is the same as I’d expect for a penny stock oil exploration firm. Speculation around new projects can cause wild swings.
So even though the dividend here could continue to be paid out, investors needs to be aware that any dividend profit could be wiped out from the share price movement. On the other hand, investors that are comfortable with the high risk stand to benefit in a large way if the company does well.
Another exploration firm
Rounding out the top three is Ithaca Energy (LSE:ITH). Here’s another oil and gas firm, which only went public in November 2022. The stock over the past year is down 23%, but it boasts a dividend yield of 15.11%.
The business is profitable, while also carrying a low level of debt. Further, from the latest results, it has $912.6m of liquidity on hand. This should help in case it has to invest in bringing projects to fruition before they generate revenue.
A project with large potential is Rosebank. Ithaca has a stake in Rosebank, one of the UK’s largest untapped oil fields. Only time will tell what this could yield the firm, but if profits are reaped in years to come, dividend payments should follow.
Of the three options, I think Ithaca is the most likely stock I’d buy for sustainable income. I believe the other two options are too high risk.
Yet even with Ithaca, I’d only look to put a small amount of money to work here.
