Dividend stocks are a great way to build a regular, hands-free income but there’s more to finding the best income investments than just buying the highest dividend yields.
More often than not, a high dividend yield reflects the market’s view that the payout is unsustainable. So, if you are looking for the best income stocks, it’s crucial to examine the sustainability of the dividend yield on offer.
Sliding profits
With a historic dividend yield of 7%, Low & Bonar (LSE: LWB) immediately looks attractive for income seekers. The big question is, can investors trust this payout?
According to the company’s half-year results for the six months to the end of May, which were published this morning, I’m inclined to believe that they can.
Even though the firm reported a 50% decline in underlying profit before tax, management at the performance materials group declared an interim dividend of 1.05p, unchanged year-on-year, based on the numbers. This might seem like a strange decision, but actually, the underlying business is relatively robust.
It’s all part of the company’s transformation programme. Management is trying to reposition the business for growth in a tight trading environment by doubling down on the areas where it has the most experience and advantage while selling off non-core divisions. Costs associated with the transformation are responsible for the drop in profit during the first half.
Even though EPS declined 49%, the dividend is still covered 1.3 times. What’s more, a keen focus on cash generation means Low & Bonar is on track to reduce net debt by £15m (just over 10%) by the end of the year — that’s on top of its dividend obligations.
These figures lead me to conclude that the dividend is safe for the time being. On top of Low & Bonar’s attractive yield of 7%, shares in the company trade at a tempting forward P/E ratio of just 7.
Slow and steady
City of London Investment Group (LSE: CLIG) manages closed-end investment funds for clients such as large pension funds. With £3.9bn of assets under management, the group is relatively small compared to fund management industry heavyweights.
Still, despite its size, it has been able to grow steadily over the past five years. From 21p in 2014, analysts are projecting EPS of 38p for 2018. Based on these numbers, shares in the asset manager are trading at a tempting forward P/E of 10.6, approximately 28% below the market median P/E of 14.8.
As well as the attractive valuation, City analysts have pencilled in a dividend per share of 27.2p for 2018, up 9% year-on-year, giving a dividend yield of 6.8%.
Not only is this distribution covered 1.4 times by EPS, but it is also backed up by City of London’s rock solid balance sheet. The company has no debt and £16.4m of cash, equivalent to 15% of its current market value, and enough to cover the dividend for two-and-a-half years. And if you factor cash into the group’s valuation, the shares are trading at a cash-adjusted forward P/E of 8.9.
So, if you are looking for a cheap, high-single-digit, sustainable dividend yield, I believe City of London is certainly worthy of further research.