At the moment, there are seven companies in the FTSE 100 and FTSE 250 that have a dividend yield in excess of 10%. As such, these are the highest yielding options available to an income investor like me. But I have two problems. I don’t have unlimited money to buy every single one. I’m also aware that a higher yield often correlates to higher risk. So which income stocks should I buy?
High yields but higher risk
There are three main sectors that contain the stocks in question. From finance there’s Direct Line Group (10.91% dividend yield) and Jupiter Fund Management (17.67%). From commodities and mining there’s Rio Tinto (12.61%), Antofagasta (10.08%), Ferrexpo (15.10%) and Diversified Energy Company (11.46%). Finally, in the property sector, I could buy Persimmon (16.30%).
In almost all cases, the share prices of the above firms have fallen over the past few months. In fact, some have experienced quite a sharp move lower. For example, the Direct Line share price has dropped by 19% in the past three months, and 33% in the past year. When the share price drops but the dividend per share remains the same, the dividend yield moves higher.
On the face of it, this is a potential red flag for me. What’s the point of having a high yield now, if the share price is falling and the business struggling? This could lead to the dividend being cut at the next earnings report.
Finding pockets of opportunity
I have to accept the higher risk. Yet this doesn’t mean that I can’t find good income opportunities. I think of it in a similar way to buying undervalued companies for growth potential. A stock that’s beaten down might be trading lower than the long-term fair value.
For example, Jupiter Fund Management has really struggled so far this year. It recorded outflows of £3.6bn for H1 as investors pulled funds out due to the war in Ukraine, high inflation and the continued hangover of the pandemic. This dragged the share price down, pushing the dividend yield up.
I think all three of the issues raised are short and medium-term problems. In a years’ time, I don’t think any of the three are going to be front page news. In such a way, I think that the Jupiter business will be able to ride out volatility until then. It’s still profitable, and so I think the dividend isn’t under a high level of threat.
The income stocks I’d buy
To reduce my overall risk, I’d split up my money and pick a selection of dividend shares. I’d buy both finance options (Direct Line and Jupiter). For commodities, I’d pick Rio Tinto and Antofagasta out of the four so that I had some exposure but wasn’t overly reliant on the movement in oil and precious metals. I’d stay away from Persimmon, as the cyclical property sector could underperform and I think there are better options elsewhere.
With my four stocks, I’d then search for some lower-yielding options in order to further reduce my portfolio risk and provide a balanced stream of future dividends.