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Here’s why the FTSE 100 could be a dividend investor’s paradise right now

I keenly await the Dividend Dashboard from stockbroker AJ Bell every quarter, and the latest update confirms what I’d thought I was seeing — it’s possibly the best time to be buying FTSE 100 dividend stocks in years.

The Footsie has traditionally offered average dividend yields of around 3% to 3.5%, but with the index having been through one of its weakest spells in a long time while share prices in many of the UK’s biggest companies have stagnated, that’s been creeping up.

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Since the start of this century, the FTSE 100 has gained a pretty pathetic 18%, so it’s really not been rewarding growth investors very well at all. But 18 years of dividends have compensated somewhat for that, so investors haven’t gone home empty handed. And those dividends have been growing.

Dividends rising

A year ago, the average forecast yield from London’s top index had risen as high as 4%, and it’s still growing. The latest forecasts suggest a total of £87.5bn is set to be handed over to shareholders in 2018, with an average yield of 4.4%.

In addition to my firm opinion that we’re in great times to be investing for income, I reckon FTSE 100 shares are looking increasingly undervalued. We’ve got housebuilders offering yields of better than 8%, tobacco firm Imperial Brands predicted to provide around 8% to 8.5% this year and next, and even plodding old energy supplier SSE is on a forecast yield of 7%.

The real beauty of buying for dividends when share prices are low and yields are high lies not just in this year’s healthy income. No, it’s all about locking in high effective yields for years to come.

If you buy in at the FTSE’s 4.4% yield today, and dividend payments only keep pace with inflation at the current rate of around 2.5%, in 10 years’ time you’ll be earning an effective rate of 5.6% on today’s purchase price.

Many of the top payers have been easily beating inflation for years, so careful selection could get you significantly more than that. I reckon you could put together a portfolio paying 5% to 6% today, and see it appreciate nicely in the coming years.

Of course, it all depends on a company’s ability to keep on paying and lifting those dividends, and that’s far from guaranteed. So what’s the best strategy for safety?

Picking the best

One approach is to look for companies which have predictable earnings with forward clarity, and which are not too capital-intensive and can afford to pay a large slice of earnings out as dividends. The utilities companies are the obvious ones, and I’ve already mentioned SSE, but my pick would be National Grid with its forecast yields approaching 6% by 2020.

Then you could go for companies with plenty of cash which can keep paying even through downturns, and Royal Dutch Shell would be my choice here. Shell stubbornly stuck to its payments right through the oil price crunch, and its yields of better than 5% should be comfortably covered by earnings by 2019.

And if you stick to stocks with dividend cover of around two times or so, you’ve got options like WPP with forecast yields above 5% and cover of just a fraction under two, and miner Anglo American whose 4%+ yields look set to be covered around 2.2 times.

Yes, I reckon dividend investors have never had it so good.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Imperial Brands and Royal Dutch Shell. 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.

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