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Standard Life Aberdeen’s 6.7% yield looks an unmissable buy to me. Here’s what I’d do

A high yield is a thing of beauty, but it can also be dangerous. You need to make sure it’s sustainable, because when a company cuts its dividend, the stock usually tanks with it.

If companies can’t generate enough cash to cover their shareholder payouts, something has to give. A number of major FTSE 100 companies have cut their dividends in recent years, including Centrica, Vodafone and SSE, and when they do, investor sentiment takes a severe knock. The Standard Life Aberdeen (LSE: SLA) share price and yield both look in fine form at the moment, the question is whether this can last.

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Standard Life Aberdeen is the UK’s largest fund manager, after being created by the merger of Standard Life and Aberdeen Asset Management in 2017. The hook-up didn’t quite go to plan, especially after Lloyds withdrew its £109bn Scottish Widows mandate as a result, although this has since been partially restored, until at least April 2022.

On the mend

The merger was designed to release synergies and generate cost savings but, so far, the benefits have been slow to come through, with earnings fallings and investor funds flowing out. The Standard Life Aberdeen share price has started to recover, rising an impressive 40% over the last year, at a time when the FTSE 100 fell.

The £7bn group’s most recent results, for the first half of the 2019 financial year, showed adjusted profit falling around 10% to £280m, largely due to net outflows in 2018 and 2019, which hit fee-based revenues. On the plus side, total assets under management rose 5% to £577.5bn.

Management is working hard to drive further efficiencies, and has also been lavishing shareholders with rewards, including share buyback programme totalling £750m, which has boosted earnings per share.

The forecast yield of 6.7% is particularly eye-catching but, my gosh, isn’t cover thin at just 0.9? You have to question whether the dividend is sustainable at this level. In fact, people have been asking that question for the last couple of years.

Time to take cover

Cover looks set to stay thin, by my calculations. By the end of 2021, the dividend is forecast to be 21.76p, against anticipated earnings per share of 20.86p. This will put cover at 0.96, only marginally healthier than today.

A further worry is that, after a 10-year bull run, markets could be starting to get choppy. Standard Life Aberdeen’s management knows this, previously warning that the current environment for asset management remains tough as macroeconomic and political uncertainties knock investor sentiment. That was written long before the coronavirus menaced markets.

There always will be macroeconomic and political clouds, and if you wait for clear blue skies, you’ll never invest in a stock like this. Unfortunately, today’s concerns aren’t reflected in the stock’s valuation of 16.9 times forward earnings, which is relatively high for a company that still has to find its feet, and has a question mark hanging over its dividend.

Not for me, at the moment.

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Harvey Jones 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.