The FTSE 100 is packed with a wide range of income stocks, some of which are offering pretty tasty-looking yields right now. Sadly, not all of these dividend-paying shares will be winning investments. And after taking a look at some of the most popular picks among investors over the last month, there are three that I’m personally steering clear of.
The shifting insurance landscape
According to AJ Bell, Legal & General (LSE:LGEN) and Aviva (LSE:AV.) are both among the most popular income stocks to buy right now. And it’s not too difficult to understand why.
These insurance giants currently offer a 9.2% and 5.6% dividend yield. Looking at their latest results, both have delivered higher operating profits across their increasingly diversified portfolios of financial products. And since that has, in turn, generated recurring cash flows, both businesses are on a bit of a dividend hiking streak of four and five years, respectively.
But as every experienced investor knows, past performance does not guarantee future results. And the shifting macroeconomic landscape in the UK is starting to create headwinds that could potentially compromise dividends.
My top concern is the state of UK gilts. Both insurance groups have large portions of their investment portfolios tied up in government bonds. As such, they’re highly sensitive to sudden movements in gilt yields, which have recently spiked to multi-decade highs on the back of growing fiscal policy concerns.
Rising gilt yields mean falling bond prices, which can create enormous problems for liability-driven investing strategies and pension risk transfers – something that both Legal & General and Aviva use to generate earnings. Put simply, if yields continue to be volatile, these firms may face a sudden wave of margin calls, triggering balance sheet and liquidity challenges.
That’s why, despite the high dividend yields, the risk surrounding these income stocks is just too high for my tastes.
Homebuilding opportunity?
Another popular pick right now is Taylor Wimpey (LSE:TW.). And again, it’s easy to see why investors are rushing to buy. Despite issues with affordability, housing demand in Britain remains exceptionally strong due to shortages. And with over 76,000 plots in the firm’s landbank, the company has ample untapped growth.
Looking at its latest results, Taylor Wimpey has even managed to accelerate its homebuilding efforts by double-digits. As such, home completions are on track to reach between 10,400 and 10,800 by the end of 2025.
So, what’s the problem? Despite operational improvements, the company continues to see its profit margins squeezed. Build cost inflation surrounding raw materials as well as labour continues to be a pest. And when throwing in unpredictable cladding remediation and regulatory settlements, Taylor Wimpey’s profits recently swung firmly into the red.
With fewer profits to spare, dividends are no longer covered by earnings. That’s fine if profits are able to rebound in the short term. But if not, management may be forced to cut shareholder payouts. And with mortgage rates ticking back up due to the previously mentioned fiscal and economic environment, Taylor Wimpey may struggle to find buyers for all its newly completed homes.
That’s why, despite the tempting 9.6% dividend yield, I’m not tempted to buy this popular income stock.
