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This FTSE 100 stock now has a 6.8% dividend yield. Here’s what I’d do  

At yesterday’s close, FTSE 100 oil and gas giant BP (LSE: BP) saw its sharpest share price rise in over three years, of 4.2%, after it announced its results for 2019. The results themselves aren’t anything to write home about, but it’s obvious why investors gave it a thumbs up. 

Rising dividends 

BP increased dividends for the last quarter of the year. As a result, its dividend for 2019 as a whole is 4.9% higher than that in 2018, at 32p. Despite the ensuing upturn in share price, its dividend yield now sits at 6.8%. This is 0.5 percentage points higher than it was just two weeks ago, when I last wrote about it. 

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The question of sustainability 

This is all very good. But the only question for me now is – can BP sustain its dividends? It has maintained or increased them in the past few years, which gives confidence. The outgoing CEO, Bob Dudley, has expressed confidence in both the strong operations and cash-flow seen by the company. What does worry me is the fact that it’s earnings per share have fallen, which may well impact dividends going forward.  

Peers comparison

Some solace can be found in the fact that Royal Dutch Shell (LSE: RDSB) released a disappointing financial report last week as well. Its share price fell fast and sent its dividend yield up to 7.3%, which is an entire percentage point higher than it was a fortnight ago.

This means that RDSB’s yield is more attractive than BP’s at present. Does that necessarily mean that the investor should prefer Shell over BP?

I’d take a step back and consider the bigger picture first. The fact is, that both companies are operating in an uncertain environment. There’s no way of knowing how far the global macroeconomic situation will be impacted by either the coronavirus or continued trade-wars, for now.

Also, the near-term future remains uncertain as oil prices are falling. Oil demand could be fairly moderate in 2020, too. Over the longer term, the future of big oil is an even bigger question mark. It depends critically on how well companies are able to transition to climate friendly fuels. So, the sustainability of both their dividend yields is called into question.

Consider alternative measures 

Knowing this, if I’m to invest in big oil to generate passive income, I’d look at one more indicator to ensure that the dividends can be maintained for now at least. One of these is the dividend cover, which is the company’s earnings as a proportion of the dividends paid. The higher the ratio, the better the cover. 

At present, RDSB is covered far better than BP, with a ratio of 1.4 versus BP’s 0.8, according to my estimates. There are varying estimates available for the cover, but RDSB seems to be a better bet across all of them. This doesn’t mean that BP isn’t likely to have a good dividend yield going forward. Only that RDSB has a higher one right now, and it’s safer as well.

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Manika Premsingh has no position in any of the shares 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.