Over the years, I’ve come to realise that one of the biggest mistakes that retail investors make is failing to take account of dividend sustainability and growth. A company may have been generous with its shareholder payouts in the past, but if circumstances change, will it be able to afford to pay future dividends? Likewise, will it be able to increase payouts over time?
Dividend cover
Let’s face it, £1,000 worth of dividends in 10 years’ time, won’t have anywhere near the same purchasing power as £1,000 generated today. That’s why dividend sustainability and growth should be of paramount importance to those looking to generate regular and reliable income from their investments.
As ever, it all boils down to earnings, i.e. the profits a business generates from normal operations or activities. As long as profits can adequately cover shareholder payouts, then dividends should be relatively safe. Generally speaking, the wider the margin between profits and payouts, the safer the dividend, and the higher the probability of future increases. That’s why it’s vital that dividend cover is taken into account when analysing potential investments.
Progressive dividend
One London-listed firm that’s always had plenty of dividend cover is commercial vehicle hire company Northgate (LSE: NTG). The Darlington-based group is now the leading light commercial vehicle hire business in the UK, Ireland, and Spain by fleet size. The group’s core business is the hire of light commercial vehicles to businesses on a flexible or term basis, giving customers the ability to manage their vehicle fleet requirements in a way which can adapt to changing business needs without the requirement to enter into a long term commitment.
Northgate remains in a strong financial position, with healthy cash generation and a robust balance sheet, all of which help to underpin a progressive dividend policy which has seen payouts rise by 137% in just four years. The shares trade on a bargain valuation of just 9.7 times earnings for the current year to April, and offer a healthy yield of 4.2%. With payouts covered more than twice by forecast earnings, there’s plenty of room for further growth.
Advertising behemoth
Meanwhile, blue-chip investors could be forgiven for thinking that the FTSE 100 couldn’t possibly offer such high levels of dividend cover at such an attractive price, given the relentless bull market of the last few years. But they’d be wrong.
The world’s largest advertising group WPP (LSE: WPP) has been out of favour with investors recently, as global growth has slowed. But the resulting share price slump has not only made the shares look cheap, but also boosted the yield on offer.
Having lost a quarter of their value over the past year, the group’s shares are now trading on a price-to-earnings multiple of 11, and offer a generous yield of 4.4%. The advertising and public relations giant has an excellent track record of dividend growth, and shareholder payouts have doubled since 2012. What’s the outlook for the ad industry? While certain categories of brand advertising may have slumped, digital ads are expanding fast so overall company adspend remains healthy meaning WPP has upbeat prospects. With forecast dividends covered twice by expected earnings, I certainly wouldn’t bet against them doubling again.