Shares in BT Group (LSE: BT.A) have endured a nightmare run since early last year, declining from around 500p to under 280p today. That’s pushed the telecommunication giant’s dividend yield up to an eye-catching 5.6%. With high street bank accounts generally offering abysmal interest rates around the 1% mark, a 5.6% yield no doubt sounds attractive. Having said that, I’m not convinced BT is a good income stock. Here’s a key reason I won’t be buying the shares for the high dividend yield.
Lack of quality
One of the best books I’ve read on dividend investing is The Single Best Investment by Lowell Miller. Dividend expert Miller explains that in order to build a ‘compounding machine’ that can pay you an increasing stream of cash year after year, there’s three things to look for in a dividend stock – a high yield, high growth of yield, and high quality.
Now while BT Group certainly fulfills the high yield criteria, with that 5.6% dividend yield being twice that of the FTSE 100 index, I’m not convinced that the company fulfills the high quality criteria.
Miller argues that for a company to be high quality, it should have low debt levels. Because interest payments will always have priority over dividend payments, high debt levels can make a company’s dividend more vulnerable. If profitability deteriorates, a higher proportion of earnings will have to be directed towards interest payments, meaning that the dividend could be at risk.
Looking at BT Group, debt is high. At the end of FY2017, the company had long-term debt of £10bn on its balance sheet, plus a gigantic pension deficit of £9.2bn. To put those figures in perspective, BT’s market capitalisation is currently £27.4bn.
Ratings agency Moody’s recently warned that BT may need to stump up £2bn in cash to plug the deficit gap over the next two years, and that could have implications for the dividend payout, in my view. As a result, I won’t be adding BT Group to my dividend portfolio for now.
Lack of consistency
Another popular dividend stock that I won’t be adding to my portfolio is BHP Billiton (LSE: BLT). Here’s why.
As a dividend investor, what I’m ideally looking for are companies that will pay me a constant stream of increasing dividends year after year. That’s the secret to building a compounding machine in which a growing stream of cash flow regularly arrives in my bank account.
To be able to pay out such dividends, it’s helpful if a business generates relatively consistent revenues and profits. Companies such as Unilever and Diageo are good at doing this. The problem with a cyclical mining stock such as BHP is that the company has very little control over the prices it receives for its products. For example, the current price of iron ore is around $60 per tonne. However, early last year, it was trading at $30.
This means that profits at mining companies can be extremely volatile, and that can limit their ability to pay consistent, increasing dividends. Indeed, last year BHP cut its dividend to just 21p, down from 82p the year before. With that in mind, I’ll be looking at other sectors of the market for high-quality dividend stocks to add to my portfolio.
Edward Sheldon owns shares in Diageo. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.