The FTSE 100 offers a tempting dividend yield of 4.4%. But if you’re prepared to invest in individual dividend stocks, then I think dividend yields of 5-8% are achievable without too much risk.
Here, I’ll look at two high-yield stocks from my own portfolio which I believe offer good value at current levels.
Follow the cash
Investors tend to focus on company earnings. But ultimately what really matters is free cash flow. Without generating surplus cash from its operations, companies can’t pay dividends, expand or even survive.
A good example of this is FTSE 100 tobacco giant Imperial Brands (LSE: IMB). This stock’s forecast dividend yield of 7.8% might suggest the payout is unsustainable. But Imperial’s dividend is covered comfortably by the free cash flow from its operations, which is considerably higher than its accounting profits.
To cut a long story short, the reason for this relates to the way past acquisitions are accounted for. If we ignore this and focus on the cash being produced by the company’s current operations, the shares start to look cheap to me.
My sums show that last year Imperial generated free cash flow of £2.4bn, or 246p per share. That gives the stock a price/free cash flow ratio of 10.6, which is fairly low. From this surplus cash, 187.8p per share was paid out in dividends. The remainder was used to reduce net debt, which fell from £12.2bn to £11.5bn last year.
Admittedly, this level of borrowing is still quite high. But Imperial’s management has committed to reducing this figure and has the firepower to do so, thanks to the group’s strong cash generation.
In my view, the dividend looks fairly safe. With the shares trading on 9.6 times 2019 earnings forecasts and offering a 7.8% yield, I rate Imperial as a buy.
I’m backing this retailer
It’s no secret that many retailers are facing tough times at the moment. But I believe some of the UK’s big names will remain long-term winners. One such company, in my opinion, is Dixons Carphone (LSE: DC).
Like fashion firm Next, which I reviewed recently, I believe that the owner of Carphone Warehouse and Currys PC World is positioning itself to be a winner as the retail market shifts online.
Chief executive Alex Baldock is working to increase the group’s online trading, where the company says its markets share is less than that of its stores. Another area of opportunity is to extend its customer credit offering, which Baldock describes as a “big profitable growth opportunity.”
The firm’s stores may need to change, but I think they will remain useful as showrooms and as collection and drop-off points for online orders, returns and aftersales services.
Not as bad as it looks
Dixons’ share price has fallen by more than 50% over the last two years, leaving the stock trading on just 7 times forecast earnings. I don’t think that the outlook is as bad as these numbers suggest.
The group has the largest market share in the UK and is growing overseas. That means it’s present in all the places customers want to shop and has a strong online brand.
Sales are expected to be flat this year and analysts expect this year’s forecast dividend yield of 5.5% to be covered 2.5 times by 2019 earnings. This suggests another cut is unlikely. I remain a buyer at this level.
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Roland Head owns shares of Dixons Carphone and Imperial Brands. The Motley Fool UK has recommended Imperial Brands. 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.