A FTSE 100 income stock with an ultra-high dividend yield is always tempting, but demands careful thought.
It’s an investment truth universally acknowledged that a yield of 7% or 8% must be approached with caution. Dividends are calculated by taking the dividend per share and dividing it by the share price. So if the share price falls, the yield automatically climbs. High yields can therefore suggest a struggling underlying business.
The average yield across the FTSE 100 is 3.25%. When a dividend hits 7%, 8%, or higher, alarm bells can ring. But there’s no hard and fast rule. Some bumper yields are genuinely sustainable. If they weren’t, I wouldn’t have bought shares in Phoenix Group Holdings (LSE: PHNX) a couple of years ago. At the time they yielded 10%, which is good by anybody’s standards.
Phoenix shares deliver dividends
The share price was going nowhere much, hence that yield. But Phoenix shares looked cheap, with a price-to-earnings ratio of seven or eight at the time, roughly half the fair value figure of 15. I ran the rule over the company’s results and saw it was profitable, just not booming.
The dividend track record was impressive, with eight hikes in the previous 10 years. This suggested the board was committed to rewarding shareholders whenever feasible.
I decided that when interest rates started to slide, yields on cash and bonds would automatically fall, making high income stocks like Phoenix look even more attractive. My hunch has largely played out, with the Phoenix share price up around 30% over the last year and 45% over two. That’s pretty handy growth, from what’s primarily an income stock. All dividends are on top.
Are shareholder payouts sustainable?
The board said it has a “progressive and sustainable” dividend policy, supported by strong cash generation from its life insurance businesses.
To keep it sustainable, it plans to increase the dividend by a modest 2% a year. That’s fine by me. I’d rather it was secure than racing ahead unsustainably.
The yield’s forecast to hit 8.22% this year, and climb to 8.46% in 2026. That really is a brilliant rate of income, but not without risks as Phoenix has to keep generating the cash to fund it.
It operates in a mature and competitive sector where any new growth opportunities, such as bulk company pension transfers, are greedily pursued by competitors. Phoenix is also at the mercy of a wider stock market crash, which some are predicting at the moment. It has £280bn of assets under management, which would take a beating if shares fell across the board. If the global economy hits an extended slump, the dividend could be cut.
Investing for the long term
Phoenix isn’t immune to market shocks, but the dividend outlook’s promising. It offer one of the best rates of income on the FTSE 100. There are risks, but I think it is well worth considering for income-focused investors who take a long-term view. To me, this shows the often overlooked power of FTSE 100 shares.
