Which firms pay really safe dividends? Two years ago, you might have said Tesco — the UK’s largest supermarket had increased its payout for 18 consecutive years.
However, this year, Tesco slashed its interim payout and decided not to pay a final dividend. J Sainsbury is expected to cut its dividend payout by 26% this year. Water utility Severn Trent recently announced a 5% cut.
Tullow Oil has suspended its payout, while City consensus suggests that if oil prices stay low for more than a year or two, even income stalwarts BP and Royal Dutch Shell could be forced to cut their payouts.
Things aren’t much better in the financial sector: Aviva‘s payout remains lower than it was in 2011, Royal Bank of Scotland Group and Lloyds Banking Group haven’t paid a dividend since 2008, and even HSBC Holdings has failed to keep pace with City forecasts.
What’s the answer?
The reality seems to be that investors who want really reliable payouts need to be willing to accept lower yields. That seems logical — but how low do you need to go?
In my view, two of the very safest payouts in the FTSE 100 are those offered by tech pioneer ARM Holdings (LSE: ARM) and pharmaceutical firm Shire (LSE: SHP) (NASDAQ: SHPG.US).
Both firms have enough net cash to cover several years’ dividend payments, as well as generous earnings cover:
|
Metric |
ARM Holdings |
Shire |
|
Dividend cover by earnings per share (2014) |
2.6 |
24 |
|
Dividend cover by net cash |
6.8 |
15 |
|
2015 prospective yield |
0.8% |
0.5% |
Both firms are also highly profitable, but I’m sure you’ve spotted the problem: low yield.
With prospective yields of less than 1%, ARM and Shire are no use as income stocks, unless you’ve held the shares since they were much cheaper.
A third option
At this point, I hope you agree that income investors need to accept some risk in order to gain access to a meaningful yield.
I reckon that one suitable candidate is Diageo (LSE: DGE) (NYSE: DEO.US), the global drinks firm.
In my view, Diageo offers the classic benefits of a sin stock — reliable long-term demand, a habit-forming product, and high profit margins — without the excessive regulatory risks that face tobacco and gambling firms.
The only fly in the ointment is the price: despite slowing growth since 2013, Diageo shares trade at 21 times 2015 forecast earnings, and offer a prospective yield of just 2.8%.
I’m beginning to think that this might be a price worth paying for access to Diageo’s reliable profits — but ultimately, the decision is yours.