Finding the market’s best dividend stocks can be tricky. The most attractive income stocks have a high yield, but a higher than average dividend yield tends to be a sign that the market does not believe the payout is sustainable. So you usually have to be prepared to trade yield for safety.
However, I’ve recently stumbled across two dividend stocks with yields of 6% that look safe even in the most adverse scenario.
Returns of 1,700% in five years
Specialist accident management and niche insurance product provider Redde (LSE: REDD) has doubled its sales during the past five years. Shareholders have been well rewarded thanks to this growth. The stock is up 1,411% since year-end 2012, excluding dividends.
Including dividends, the returns are even more impressive. Redde has consistently distributed around 100% of earnings per share to investors every year, and as a result, the yield on the shares has remained above 6%. Including these dividends, the total return has been 1,700% since year-end 2012.
It looks as if the firm can keep this track record going. In a trading update published today ahead of the company’s AGM, management said the positive start to the financial year has continued and “as a consequence, trading profits are ahead of the corresponding period last year.” The announcement also confirmed the prospect of £17m or 5.6p per share for the dividend, the “12th consecutive dividend since June 2013. Payments since that date will amount to £105m representing 38p per share.“
The key to dividends
Cash flows are the key to dividends. Luckily for investors, Redde is a cash cow. For fiscal 2017 the company generated a free cash flow of £43.6m before dividends.
According to my numbers, payouts cost the company £30m, so the distributions were easily covered by cash generated from operations. Over the past five years, the firm has produced £171m in cash and paid out only £86m leaving plenty of headroom for other purposes. All in all, Redde looks like a top income stock to me.
Despite concerns about its business model, Connect Group (LSE: CNCT) also appears to be generating mountains of cash. According to my figures, for fiscal 2016 the firm reported a free cash flow of £44m, easily covering dividends paid, which totalled £23m. The same trend can be seen for the past five years. The average free cash flow/dividend cover ratio for the company for the past five years is two times.
Concerns about Connect’s future have weighed on the company’s stock this year. The distribution company’s shares have lost around 40% of their value as investors bail out due to concerns about the firm’s ability to survive as paper sales slide. For the full year, City analysts are projecting a decline in earnings per share of 18%.
Still, even though Connect’s outlook is mixed, the shares trade at a bargain basement valuation of only 6.1 times forward earnings, which in my view more than makes up for the uncertainty. Connect also supports a dividend yield of 10.2%.
As shown above, this distribution seems to be well covered and secure for the time being. So, despite worries to the contrary, Connect looks to be a great income share to me.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.