With interest rates unlikely to move significantly higher over the next few years, dividends are set to become an even more important part of an investor’s total return. Certainly, there are a number of stocks on the FTSE 100 which offer much better income prospects that the 2% or below rate that is on offer in cash savings, but not all companies with such high yields offer good value, sustainability and upbeat forecasts.
One company which has a dividend that appears to be unsustainable at its current level is insurance group, Admiral (LSE: ADM). Certainly, its yield of 6.2% holds tremendous appeal and is above and beyond the vast majority of so-called ‘high yield’ stocks on offer in the FTSE 350. However, Admiral pays out almost all of its profit as a dividend, which leaves very little to reinvest in the business in order to grow its profitability over the medium to long term.
In fact, Admiral currently pays out around 97% of profit as a dividend and, with the company’s bottom line having fallen by 2% last year and set to fall by 10% this year, it is not a particularly stable business. As such, a very high payout ratio may not last in the long run, although even if it were cut to a more reasonable level of around 75% it would still leave Admiral as a top notch income stock, with it having a yield of 4.8%. As such, even if dividends are cut, Admiral remains an appealing dividend stock.
Another consideration for income-seeking investors is how reliable dividends will be. In other words, external factors or shocks could hurt a company’s financial performance and force it to cut dividends. One sector which is a good example of this is the oil producing space, where profitability at oil majors such as BP (LSE: BP) (NYSE: BP.US) has fallen dramatically in recent months. And, while BP yields 5.8% at the current time and has stated that dividends remain a priority, further falls in the price of oil could force it to slash dividends. As such, and while BP is a great income stock, it may not give its investors peace of mind – especially if they rely upon their dividend income to fund their day-to-day expenses.
That’s where utility stocks fill a much-needed gap. Companies such as United Utilities (LSE: UU) offer a very dependable and reliable income stream. Certainly, United Utilities is hardly cheap, with a price to earnings (P/E) ratio of 22.2, but it continues to have significant bid potential due to its extremely reliable dividend payments. And, while United Utilities may yield a lot less than BP and Admiral, with it currently yielding 3.9%, investors can buy a slice of the company, sit back and collect their dividends twice a year without a great deal of worry. In my view, that makes United Utilities the best dividend stock of the three, although BP and Admiral remain well-worth holding as part of a diversified portfolio.
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Peter Stephens owns shares of BP and United Utilities Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.