Dividend stocks are shares that can provide investors with a steady stream of income. For those interested in passive income, investing in high dividend yield stocks can be a great option.
This guide will explain what high dividend stocks are, what to look out for when buying them, and some of the top UK companies in this sector.
What are high dividend stocks?
A dividend stock is a company that distributes a portion of its profits to its shareholders.
Dividends are essentially a way that companies thank their shareholders for investing in them. The level of the dividend is set by a company’s board, and an investor receives a dividend for each share they own.
A high dividend stock, meanwhile, is a company whose yield looks enormous based on certain comparatives. The yield measures the level of a dividend by calculating it as a percentage of a stock’s share price.
Let’s say that a dividend stock trades at 100p per share. If analysts predict a 5p per share dividend for the current financial year, then the yield comes in at 5%.
There are various ways that one can judge whether a company is a high-yield dividend stock. A company’s yield can be compared to the average yield on offer from all UK shares. It can also be compared to the broader yield on an index (say, the FTSE 100) or to other companies within the same industry.
Top high dividend stocks in the UK
There is a lot more to consider when choosing the best income shares than simply what companies offer the biggest dividend yields. Fortunately, there is a huge selection of dividend stocks with large yields to choose from in the UK today. These three high-dividend yield stocks are all from the UK’s FTSE 100, and are some of the largest by market capitalisation.
|SSE (LSE: SSE)||Perth, Scotland||An energy producer with a focus on renewable sources|
|Barratt Developments (LSE: BDEV)||Coalville, England||One of the UK’s largest builders of private and affordable homes|
|International Distributions Services (LSE: IDS)||London, England||The UK’s oldest courier with a growing overseas footprint|
Utilities business SSE has a long history of offering above-average dividend yields. As of December 2022, its annual yield sits at 5.2%, far above the 3.7% average for all FTSE 100 shares.
On paper, SSE is a high dividend stock with some notable red flags. The capital-intensive nature of its operations means it has a lot of debt on the balance sheet.
However, SSE provides an essential service, which means profits remain broadly stable during economic upturns and dividends. This also gives it considerable cash flows to remain a high dividend stock despite those high debt levels.
SSE’s focus on wind energy could help it to deliver excellent shareholder returns as demand for low-carbon power takes off. SSE plans to increase its renewable output fivefold by 2030.
Housebuilder Barratt Developments is another high dividend yield stock from the FTSE 100. At 8.99% as of December 2022, its forward yield is also more than double the broader Footsie average.
Homebuilders like Barratt have large profit margins. This means they generate lots of cash with which to pay large dividends. A projected dividend of 39.1p per share is covered 2.1 times by anticipated earnings. Finally, Barratt’s payout ratio has largely remained at healthy levels between 30% and 40% over the past decade.
A problem for Barratt is that its operations are highly cyclical. Demand for its newbuild homes could slump if economic conditions worsen and dividends could suffer as a result. Rising interest rates might also damage sales of its product.
At the same time, profits at Barratt could remain solid if Britain’s shortage of residential properties drags on. Barratt builds homes of all types and sizes across the whole of the UK.
International Distributions Services
Courier International Distributions Services, formerly known as Royal Mail, can trace its origins all the way back to 1516, though its operations are changing rapidly in the digital age. Letter volumes has plummeted as email has taken over. Meanwhile, parcel volumes are soaring due to the emergence of e-commerce.
It’s important to note that Royal Mail’s payout ratio has fluctuated wildly and at high levels, too, over the past 10 years. This reflects the economically sensitive nature of its business that affects earnings, and also the high costs of its ongoing modernisation programme.
Royal Mail generates the lion’s share of profits from its traditional British marketplace. The company is expanding rapidly though through its GLS division, which operates across Europe and North America.
What to look for in high dividend yield stocks
There are two important numbers to pay special attention to when evaluating high dividend shares: the yield and the dividend payout ratio.
Dividend yield is the first thing one considers when selected high dividend stocks to buy. However, it’s critical to remember that forward dividend yields are based on a projection of the dividends that analysts believe a company will pay.
If a stock’s profits start to come under pressure, these dividend forecasts can suddenly look extremely fragile.
Furthermore, companies with extremely high dividend yields can sometimes prove to be investment traps. Their gigantic yields could be caused by significant share price falls, which in themselves might suggest that market participants expect profits to dive.
There are a few things to consider when assessing which high dividend yield stocks to buy in the UK. They can give you a decent idea of how realistic a company’s dividend projections appear. These include:
- The level of dividend cover. This looks at how well a predicted dividend is covered by expected earnings. A reading of 2 times and above suggests that a company is in good shape to make the projected payout based on profits.
- The strength of their balance sheet. Businesses with lots of debt may have to compromise on dividends to meet their financial obligations. Those with weak free cash flows may also struggle to pay decent dividends.
- The nature of their operations. High dividend stocks that operate in defensive industries may be in better shape to shell out large payouts year after year than those in cyclical sectors. This is because they can theoretically expect profits to remain stable even during economic downturns. Utilities, telecoms providers and food producers are some examples of defensive stocks.
Dividend payout ratio
It’s also important to assess whether a high dividend stock can continue to pay decent rewards to its shareholders over the longer term. This is where the dividend payout ratio comes in.
The dividend payout ratio illustrates what a business is paying in dividends as a share of their profits. A stock that has earnings of 100p per share and pays dividends of 70p per share has a payout ratio of 70%.
There is no set rule as to what makes a decent payout ratio. However, stocks whose payout ratios suddenly jump — and shares that have payout ratios above 100% — can sometimes be extremely dangerous.
Are high dividend shares right for you?
High dividend yield stocks could be a good option for UK investors who are looking to build a healthy second income, and for those who are looking to become financially independent.
If you invested £2,400 in high dividend shares yielding 5%, you’d have £120 in secondary income in the first year. In the second year you’d hopefully continue to receive dividends from these shares, too, as well as dividends from any new stocks you’d bought. And so on.
The income flows that these high-yielding shares can significantly boost one’s wealth levels over the long term. Buying dividend shares is a popular way that people try to build a passive income (this is a steady stream of cash that requires no day-to-day activity). If you’re looking for a more passive style of building wealth, investing in high dividend shares could be a good option for you.