The impact of the Covid-19 pandemic is still ongoing and still affecting the FTSE 100 stock market. On top of the move lower in the FTSE 100 index, individual firms within it are also impacted. Sectors such as aviation, travel, and retail are just a few that are struggling.
Here at The Motley Fool, we believe in investing for the long term, and so see some good opportunities to buy given the cheap valuations on offer. A side impact of cheaper valuations is that it artificially boosts the dividend yield of a company.
As an example, let us say you bought a stock at 100p and it paid a dividend of 10p. Your dividend yield would be 10%. But if the share price dropped to 80p, the dividend yield increases to 12.5%. This is good news for new investors, as they can effectively lock in the higher dividend yield by buying the share at a cheaper price.
The risk of this is that dividends are not guaranteed with ordinary shares. A company can decide to decrease or even cut a dividend all together for a year, depending on financial performance. While the board of directors aims to keep paying a dividend in order to keep shareholders happy and invested during bad times, it does not always happen.
Which FTSE 100 firms have announced a cut?
One of the biggest announcements of a dividend cut came last Monday, when ITV said it would not pay £213.6m in dividends. This is part of a £300m cost-cutting exercise, needed to offset a fall in advertising revenue.
UK housebuilder Persimmon also announced that it was cancelling its next two dividend payments. Like ITV, the housebuilder is seeking to cut costs, due to a dry up in demand for new houses. Even finished projects will likely see stagnant demand until uncertainty has passed.
How can I be sure of receiving a dividend?
There are two ways that income investors can aim to still pick up dividends by investing in FTSE 100 firms. Firstly, look at the size of the share price fall and the updated dividend yield.
For example, the ITV share price is down over 55% in the past three months. Using the previous year’s dividend of 8p per share, and a share price of 67p, this would be a dividend yield of 12%. This looks unsustainable in light of the firm’s historical dividend yield. Hence, we have seen it cut. There are plenty of other shares now yielding 10% or even 20% yields which start to raise alarm bells for me.
Secondly, look at the firm’s dividend cover. This measures the profit of a firm versus how much is paid out as a dividend. A cover of 1 means the dividend can be paid entirely from profit. To feel safer about continuing to receive a dividend, I would be buying firms with a cover of at least 1.5.
In my opinion, seeking reliable dividend income at the moment is tough. That is why I am focusing more on buying stocks for capital appreciation. I’m looking for stocks that are fundamentally undervalued in the long run.
Jonathan Smith does not own shares in any firm mentioned. The Motley Fool UK has recommended ITV. 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.