Can we really trust today’s high-yielding dividend stocks?

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Anybody who loves top dividend stocks will struggle to resist going on a buying spree at the moment. The FTSE 100 is packed full of them.

Some of the yields on offer are astonishing. Housebuilder Persimmon currently yields 17.9%. That’s the best on the FTSE 100 but mining giant Rio Tinto isn’t that far behind, with a yield of 12.87%.

Fund manager Abrdn yields 9.37%, insurer Phoenix Group Holdings yields 9.07%, and builder Taylor Wimpey yields 9.05%. Wow.

I’m buying dividend stocks today

There are plenty more where those came from. In fact, I can hardly remember a time when yields were so high. But can I trust them?

A yield is calculated by dividing a company’s dividend by its share price. So if the dividend is 5p and the share trades at £1, the yield is 5%. This means that if the share price halves, say, to 50p, the yield doubles to 10%. 

As this basic example shows, a high yield is often the sign of a company in trouble. It signals both an opportunity, and a threat.

If stock markets are down generally and my chosen dividend stock has got caught up in the wider malaise, then I’ll see that as an opportunity. Loads of stocks fits the bill right now, thanks to this year’s global political and economic turmoil. 

But I would also work through its reports, statements, and updates, to see whether there are problems specific to that company. In particular, I would look to see whether management can afford to continue paying its dividend. The easiest way of doing this is to check dividend cover. This is calculated by dividing shareholder payouts by company earnings, but it can also be found easily online. 

Ideally, it will be covered twice or more. This figure is often lower with utilities, where earnings are typically more reliable, allowing companies to hand more of them to shareholders. A healthy level of cover is no guarantee, but it’s a promising sign that the company will be able to continue paying me passive income in future.

I would also look at other company numbers, such as the size of its net debt and of course the reliability of its free cash flows, which fund shareholder payouts. Similarly, I would prioritise firms with a lengthy track record of making dividend payments. Especially those who maintained them through thick and thin (and the pandemic, too). 

FTSE 100 offers amazing yields

Any company that increases its dividends year after year would be high on my list, as this gives me a rising passive income. While past performance is no guide to the future, it does offer reassurance.

As a general rule, I would prefer a company with a lower dividend that looks more reliable, than a higher dividend that is likely to be cut. When a dividend is cut for being unaffordable, the company’s share price tends to bleed, too.

Naturally, a host of other factors will determine whether the dividend is sustainable. A strong balance sheet, loyal customer base, unique brand, or popular products can all help secure those all-important cash flows. 

While I’m thrilled by all the top FTSE 100 dividend stocks out there right now, I’m doing some careful sums before buying them.

The post Can we really trust today’s high-yielding dividend stocks? appeared first on The Motley Fool UK.

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Harvey Jones holds shares in Persimmon. 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.