With the FTSE 100 trading at record highs, the average dividend yield offered by the big-cap index is falling. And some of the remaining high-yield stocks look decidedly risky to me.
In this article, I’m going to look at three high-yield stocks which I believe offer attractive upside potential.
Neil Woodford’s top financial
Legal & General Group (LSE: LGEN) was fund manager Neil Woodford’s biggest financial holding at the end of December, accounting for 5.5% of his Equity Income Fund.
In my view, it’s easy to see why Mr Woodford is attracted to this life insurance and asset management group. The group’s generous dividend is covered around 1.5 times by earnings. Legal & General is expected to pay a 14.3p dividend with respect to 2016, giving a forecast yield of 5.9%.
A second attraction is that Legal & General’s earnings growth has been stronger than you might expect. The group’s scale has enabled it to win a number of large bulk annuity deals, offsetting the impact of changes to pension rules.
L&G’s earnings per share have risen by about 45% since 2012. The group currently trades on a forecast P/E of 11.5 with a prospective yield of 5.9%. I rate this stock as an income buy.
The outlook is improving
Utility group SSE (LSE: SSE) has struggled to maintain dividend cover and protect its policy of inflation-linked dividend growth over the last few years. But the outlook is improving. This year’s forecast payout of 91.4p per share is expected to be covered 1.3 times by earnings of 121.5p per share.
One risk that may be worth watching is that SSE’s customer numbers are falling. The total number of energy customers fell by 1.5% to 8.08m during the nine months to 31 December. Average electricity and gas consumption rose over the same period, offsetting some of these losses. But it would be good to see evidence that SSE can stem the outflow of customers.
Despite this concern, I believe SSE looks attractive at current levels. The stock trades on 13 times forecast earnings, with a prospective yield of 5.9%. That seems reasonable to me.
Further gains likely
Shares of Direct Line Insurance Group (LSE: DLG) have risen by more than 80% since the firm floated in 2012. The group has established a solid reputation among investors since joining the market.
One reason for this is that Direct Line has managed to balance the conflicting demands of growth and profitability. This has improved the group’s return on equity and generated surplus cash for special dividends.
Direct Line is expected to pay a total of 31p per share in dividends for 2016. This equates to a massive forecast yield of 8.5%. Some caution is necessary here, as around half of this payout is likely to be in the form of a special dividend. These payments vary depending on surplus cash generation. Unlike the group’s ordinary dividend, shareholders shouldn’t expect special dividends to rise every year.
Notwithstanding this, I believe Direct Line could be an attractive income pick at 370p. The shares’ forecast P/E of 11.5 looks undemanding to me. The yield should be high enough to compensate for limited near-term earnings growth.
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Roland Head owns shares of SSE and Legal & General 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.