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Why I’d pick the FTSE 100’s 2 highest yielding shares

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Looking at the top end of the FTSE 100 dividend league today there are some juicy looking yields. But the highest yielding shares often divide opinion as to their future prospects.

Here I look at a bull and bear case for the two highest yielding shares in the FTSE 100 right now.

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M&G: a bull case

Investment manager M&G (LSE:MNG) offers a yield of 8.8%.

This month, the company announced a dividend increase. The increase was fairly small, at 2.6%. But it was seen as a sign of confidence from the company. That is in line with its stated target of a stable or increasing dividend.

Basic earnings per share of 44p grew from last year. The dividend is covered more than twice by earnings.

Trading at a price-to-earnings ratio beneath 5, the share looks undervalued to me. There is continued space for demand growth in the investment management space. M&G’s well-known brand can help it to attract customers and benefit from future growth.

A bear case for M&G

A high yield is often a signal that the market expects possible bad news in future, such as a dividend cut or reduced earnings.

One of the difficulties in valuing M&G is that it has a short history as an independently listed company. It was only spun out from Prudential in 2019. That means some investors may be wary of the company until it has a longer financial record as an independently traded share.

The market for investment management can be affected by factors such as a fall in savings rates, economic downturn or new regulations. While the pandemic has boosted savings rates, they could fall once the broader economy reopens.

FTSE 100’s highest yielding shares

Right now, the highest yielding shares in the FTSE 100 are those of Imperial Brands (LSE:IMB).

The most recent dividend payout was today, reminding existing shareholders like myself of the attractive yield. Offering a yield of 9.2%, Imperial puts even M&G’s payout slightly in the shade.

While cigarette consumption is declining in key markets, Imperial has set out plans to move into other tobacco formats where it sees growth opportunities. Meanwhile, it is working to shore up its cigarette market share in its key markets. In a trading statement yesterday, the company said that it was now seeing such market share growth across these five markets in aggregate. It reassured the market that trading is in line with expectations.

Like M&G, Imperial has a single-digit P/E ratio, less than six.

An Imperial bear case

Although the yield is strong, last year the company cut its dividend after many years of increases. That makes the dividend more affordable for the company. But it is a harsh reminder that no dividend is ever guaranteed.

Smoking is declining in many markets yet remains central to Imperial’s business. Selling its premium cigar business helped the balance sheet – but will make it harder to maintain earnings. The dividend is covered by earnings, but less than in M&G’s case.

What I’ll do now about the highest yielding shares

On balance, I see easier growth prospects for M&G than for Imperial in coming years. That could make dividend maintenance easier.

I already own Imperial. My next action is considering opening a position in M&G. That would give me exposure to both of the FTSE 100’s two highest yielding shares.

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christopherruane owns shares of Imperial Brands. The Motley Fool UK has recommended Imperial Brands and Prudential. 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.

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