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FTSE 100 investing and high dividend yields

Different investors have different levels of risk tolerance. Volatility in stock prices, especially over the short run, is a concern for most retail investors, especially as they approach retirement years. In general those investors would like to build a portfolio of shares that can provide them with both regular income and some capital appreciation, all within a risk level that they can tolerate on a short-term basis.

Today, I’d like to discuss shares that yield high dividends (income) so that investors may make better-informed investment decisions.

The dividend yield of FTSE 100

A dividend is a distribution from a business to its shareholders. Dividends, which are usually paid from after-tax profits, are determined at the discretion of a company’s board of directors. 

When a business sets the dividend for the year, management is essentially doing the research for the investor. The board takes a hard look at the company’s fundamentals as well as the industry conditions. The dividend amount set possibly represents the most appropriate amount by the people who know the company best.

The FTSE 100 consists of the 100 UK-listed stocks with the biggest market capitalisations. As one of the highest-yielding markets in the world, the FTSE 100 currently has a generous dividend yield of 4.5%. 

Most of the shares in the index declare regular dividends. Notable exceptions are Ocado Group and Just Eat.

High dividend yields

Dividend yield shows investors what percentage a specific share returns relative to its price.

For example, if a stock trades at £50 and the company’s total annual dividend is £2.50, then the dividend yield is 5%, or £2.50 divided by £50.

As the average dividend yield of FTSE 100 is currently 4.5%, investors tend to regard high dividend yields as over 4.5% or even 5%.

However, dividend yield is a metric and investors should not make investment decisions using high dividend yield as their only or even main investment criterion.

The yield might be high simply because the share price has been in decline for important fundamental reasons. 

For example, consistent free cash flow (FCF) generation is regarded as the hallmark of a stable dividend-paying company. If the business has cash flow issues, it may not be able to pay high or even any dividend in the near future.

Earlier in the year two high-profile companies, namely Vodafone and Royal Mail, cut their dividends. Sometimes a dividend cut may almost be necessary as businesses go through various cycles of the economy.

Investors should also look at the consistency of a company’s history of earnings and earnings growth. The dividend amount can be an indication of management’s confidence in the company. If it is confident that an increased level of earnings can be maintained, then there is a good chance of the dividend being increased, leading to a higher yield.

Several FTSE high-yielders that investors may want to do due diligence on to consider for their portfolios are Aviva (yield of 7.9%), BP (yield of 6.7%), DS Smith (yield of 4.7%), or Rio Tinto (yield of 6.1%).

Finally, if you are interested in dividend stocks, but not quite sure where to begin, a low-cost FTSE 100 tracker fund might also be appropriate.

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tezcang has BP covered calls (October 11 expiry) on BP ADR shares listed on NYSE. The Motley Fool UK has recommended DS Smith. 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.