As an investor, I certainly like the passive income prospects offered by dividends. But while a dividend stock may dangle a juicy yield, that is never guaranteed to last. After all, a dividend can always be cut at any moment.
That helps explain why, like any sensible investor, I diversify my portfolio across different investments. It also explains why I look at the source of a company’s dividend when investing. And then consider how sustainable it looks in the future.
That is true for dividends of any size, although sometimes high-yield shares can present a specific red flag when it comes to dividend sustainability.
FTSE 100 company with a high yield
That brings me to FTSE 100 insurer Phoenix Group (LSE: PHNX).
For a blue-chip company in the lead index, its 7.9% yield is eye-catching. That is well over double the current FTSE 100 yield. But Phoenix’s directors aim to keep growing the dividend per share annually, as they have been doing over recent years.
So is it sustainable?
Looking at the source of income
When assessing how well-covered a dividend is, financial services companies can be hard to evaluate. A brick maker or airline, for example, has money coming in from customers to pay for goods or services, that it then needs to deliver. So assessing the accounts can seem relatively straightforward (though in practice it may not always be so).
But an insurer is typically seeing cash flow in or out on a large scale that is not its own, but that of its clients. Meanwhile there are rules about how to account for investments it holds essentially on their behalf. That means fluctuations in their value can affect the profit and loss account of a financial services firm even if its cash position has not necessarily changed.
Phoenix’s mortgage book is an example. The company has made certain assumptions about the value of the properties in it. If there is a property market crash and those assumptions are too generous, that could lead to the company’s profits falling.
Clearly that it is an actual risk. Properties could be worth less after a property crash than they are now. But along the way (sometimes for decades) such assumptions and shifting valuations can make it complicated to assess how sustainable a financial services company’s dividend may be.
Large company, proven business model
Phoenix again provides an example. Last year, on an International Financial Reporting Standards (IFRS) basis), Phoenix’s loss after tax was £1.1bn. That might sound alarming for a company that spent £533m on paying dividends.
But profit and loss is an accounting measure (albeit a helpful one). The company’s total cash generation last year was £1.8bn. That is a dramatically different figure to the reported loss after tax – and explains why Phoenix was able to grow its dividend per share by 3% and express confidence in ongoing annual dividend per share growth.
Phoenix’s brands such as Standard Life serve around 12m customers and it has almost £300bn of total assets under administration. It has a proven business model and deep insurance market expertise. I am optimistic that can help it continue to generate large amounts of surplus cash.
I see it as a dividend stock for investors to consider.
