Tobacco focus: Imperial Brands

With a portfolio of tobacco brands including Lambert & Butler and Gauloises, Imperial Brands (LSE: IMB) is able to appeal to customers in a wide variety of markets. It can target smokers willing to pay a premium for their puffs, as well as more price-conscious purchasers. That all translates into sizeable cash flows that can help support the company’s dividend.

Currently, Imperial shares yield 8.6%. So if I put in £1,000 now, I’d expect to get around £86 of passive income in 2022. Indeed, Imperial’s next payout is scheduled for this week, although I’d be too late to receive that if I bought the shares today. But with another one due just three months from now, buying Imperial today could hopefully boost my passive income streams from the first quarter of 2022 onwards.

But there are risks with Imperial Brands. Primary among these is the company’s large exposure to the cigarette business. Falling consumer demand in many markets and tighter government regulation could hurt both revenues and profits in years to come.

Iconic insurer: Direct Line

Another company with a juicy dividend yield is insurer Direct Line (LSE: DLG). Its shares are currently yielding 8%.

The company has a well-known brand, which helps it attract and retain customers. I see that as a positive asset for the business, as it could help it control its costs over the long term if it reduces customer acquisition expense. On top of that, I like the company’s focus on fairly stable areas such as motor and home insurance. While cost competition can sometimes damage profit margins in this market, demand is fairly consistent. From year to year, payout costs shouldn’t vary dramatically, unlike in some parts of the insurance market. That should be good for the company’s economics.

One thing that is interesting about Direct Line, though, is its price. Despite the juicy yield, the Direct Line share price has lost 11% over the past year, as of the time of writing this article earlier today. I wonder if that reflects growing concern about the impact new rules around insurance renewal prices could have on the profits of companies such as Direct Line? If the rules squeeze insurance pricing as feared, they could lead to lower profits.

Financial services powerhouse: M&G

Another company I would choose in financial services, although a different part of the sector to Direct Line, is asset manager M&G (LSE: MNG).

The company’s yield of 9.1% is among the highest available right now from any FTSE 100 stock. The company has also said it plans to maintain or raise its dividend in future. That is not guaranteed, but if it happens, then buying M&G for my portfolio today could mean I lock in almost a double-digit yield.

I think the company’s business area is attractive. Huge amounts of money get invested by clients, so it is a big market. Given the size of the funds involved, even a modest commission in percentage terms can translate to sizeable revenues and profits. One risk is any slide in investment performance. If M&G funds don’t perform well, customers could move funds elsewhere, hurting revenues and profits.

Consumer goods giant: Unilever

It hasn’t been a great year for consumer goods company Unilever (LSE: ULVR). Its shares have drifted down 10% over the past 12 months.

That could be good news for me as a yield hunter though. A lower share price equates to a higher dividend yield, especially as the owner of Dove and Marmite has continued to raise its dividend. Currently, Unilever shares yield 3.7%. The basic characteristics of the business lend themselves well to large cash generation. Unilever sells products used by several billion customers each day. The company’s premium brands give it pricing power. This means that even in economic downturns, Unilever ought to be able to keep sales revenues substantial and maintain attractive profit margins.

One risk to profit margins currently, which the company highlighted this year, is ingredient cost inflation. This has been rampant and if Unilever can’t pass it on to consumers in the form of higher prices, profit margins could suffer.

But I see the recent weak performance of Unilever shares as an opportunity to add a blue-chip company to my portfolio at an attractive price. On top of that, the yield could help boost my passive income streams.

Investment trust: Income and Growth VCT

When looking at some 10%+ yielders last month, one of the names I considered was the venture capital trust Income and Growth (LSE: IGV). Since then, the trust has declared a 4p interim dividend, which is due to be paid next week.

That will take the trust’s dividend payments for the year so far to 9p. That’s almost 10% of the current Income and Growth share price – and there could still be further dividends declared this year.

I am not surprised, as the company has a track record of making successful investments in small companies that allow it to reward its own shareholders with juicy dividends. But this approach entails risks too. Such companies tend to be illiquid, so the timing and size of the trust’s income can be volatile. That also means dividends can move around a lot. Last year, for example, the payout of 14p was well over double the 6p paid in the previous year. Still, with those sorts of dividends, IGV is among the top passive income ideas for 2022 I would consider for my portfolio.

Diversified Energy

I recently opened a position in Diversified Energy (LSE: DEC), a significant reason for which was its dividend yield. Currently, the energy well operator yields around 11.0%, which I find very attractive. On top of that, it has raised its dividend annually over the past several years, although that is not necessarily an indicator of future dividend levels. Another attraction from a passive income perspective is that Diversified pays out quarterly.

But an 11% yield is unusually high – could that be a warning signal for potential risks with the share? I do see a number of risks in owning Diversified. Falling energy prices could hurt profits. Shifts in the energy demand mix could lead to declining revenues. There is also the clean-up cost associated with the company’s thousands of aging wells. Such costs could hurt profits in coming years. Recognising these risks, however, I continue to find Diversified compelling enough to have bought it for my portfolio as we head towards 2022. Its large, growing portfolio of energy wells should keep it pumping oil and gas for many years to come. I expect there will still be demand for such energy even as alternative sources become more popular. Growing overall energy demand should benefit Diversified despite its heavy reliance on oil and gas.

Direct Line

A well-known brand can be helpful for a company’s prospects. It can give it pricing power, allowing it to attract customers and earn attractive profit margins rather than being forced simply to compete on price. With the increasing price visibility brought to the insurance market by online comparison sites, I think that has become especially true for insurers. One insurer I think benefits from a strong brand is Direct Line (LSE: DLG).

Its pricing power isn’t the only thing I like about Direct Line from an investment perspective. It is also a generous dividend payer. Direct Line shares currently offer a prospective yield of 8.0%. I’d be happy to add Direct Line to my portfolio for 2022 and beyond. But I do see some risks here. For example, the rising cost of used vehicles could push up the company’s claim settlement costs. That might lower profits.

Income and Growth Trust

I wrote about venture capital trust Income & Growth (LSE: IGV) last month in a rundown of double-digit yielding dividend shares I was considering for my portfolio. I noted then that it had paid out 5p per share so far this year in dividends, but further payments were as yet unknown. Last week, the trust declared an additional 4p per share interim dividend. That means that, so far this year, it has declared 9p of dividends per share. With its trading price around 91p at the time of writing this article yesterday, that means that this year’s yield from the shares is almost 10% even without any final dividend yet being declared.

Last year’s payout per share totalled 14p and the year before that it was 6p. So the dividend can move around a lot. But the trust’s track record shows that it has been able to generate funds for significant dividend payments. It does that through investing in a portfolio of young companies and hopefully benefitting from their growth. Such an approach can bring risks as well as rewards, though. If the trust manager chooses promising companies that then fail to blossom, its profitability could suffer.

Imperial Brands

I hold both of the two main UK-based tobacco companies in my portfolio, British American Tobacco and Imperial Brands (LSE: IMB). Both benefit from the rich cash generation characteristics of the tobacco business. Production costs are low and the companies have strong pricing power, which can help fund large dividends.

BAT’s trading update this week was well-received by the market. The shares have moved up over the past few days. Its yield of 7.9% still looks attractive to me, but right now I’d happily add more Imperial to my portfolio. It currently yields 8.8%.

Imperial has scaled back its ambitions in so-called next generation products, which are cigarette alternatives like vaping. I think that could be both good and bad for the shares. The good aspect is that it saves Imperial from spending heavily to build market share in an area which isn’t yet strongly profitable like cigarettes. But the bad part is that it could mean Imperial becomes more dependent than competitors on cigarettes. Cigarette demand is declining in many markets. Imperial is trying to combat that with price increases and increased marketing to grow its market share. But long term, its cigarette focus could be a risk to revenues and profits. Meanwhile, though, I reckon it could keep making large profits from cigarettes for years or decades to come.

M&G

Another of the high yield dividend shares I would consider adding to my portfolio for next year is financial services firm M&G (LSE:MNG).

Like Direct Line, the company benefits from a strong brand. I also like the economic characteristics of the investment management business in which it operates. The size of many customers’ investments means that even with a modest commission, M&G should be able to earn a handsome profit. Last year, for example, the company reported a post-tax profit of £1.1bn. That compares to its current market capitalisation of £5.1bn, putting the M&G share price on an attractive valuation for me.

Such profitability can translate into chunky dividends. Currently the shares offer a 9.3% yield. M&G is committed to maintaining or raising its dividend, although of course if it runs into unexpected business headwinds that could change. One such headwind could be increased competition in financial services driving down profit margins.

5 high yield dividend shares

With each of these shares yielding 8% or more, I’d pay particular attention on risk as well as potential reward. Do the yields reflect some hidden danger?

I simply can’t know — that’s the nature of a hidden danger. That is exactly why I seek to reduce my risk by diversifying across different shares when I add to my portfolio. I’d happily hold all five of these shares in my portfolio together.

In this article I’ll consider some common mistakes in hunting yield, and then look at some shares that currently have a double digit. I’ll consider whether buying them for my portfolio would meet my investment criteria.

Common yield-hunting mistakes 

When looking for yield, like many investors, I have found that there are some simple errors that can trip me up.

One is paying too much attention to historical data. This is an easy mistake to make: after all, the only hard data one has on a company’s dividends is from its historical payouts. Any future dividend data is essentially just a forecast. Nonetheless, past dividends aren’t necessarily a guide to future payout levels. I find that can be particularly true when it comes to high yielders, as often a share’s high yield implicitly signals that the City is pencilling in a dividend cut.

Another common error is thinking of dividends as fairly static. For some shares, they are extremely dynamic. There can be many reasons for that: swings in commodity prices, shifting capital allocation priorities, and rules on what a company can pay out are just three. But it can mean, for example, that a company with a high yield pays great dividends for another year or two, then nothing for a decade, before later becoming a generous payer again (or not, in some cases).

Bearing in mind such common missteps, here are four double-digit yielding shares I could consider for my portfolio today. Only one of them appeals to me right now, for reasons I explain below.

Rio Tinto

Let’s start with the massive mining company Rio Tinto (LSE: RIO). Last year, Rio Tinto paid out a dividend of $5.57 (although it is listed in pounds in London, the dividend is paid in dollars). So far this year, it has paid $5.61 in dividends. That doesn’t include a final dividend so far. If the final dividend is increased as much as the interim dividend was, it would come in around $7.50. That would make for a total dividend this year of $13.11. At the current share price of around £44.04, that implies a massive prospective dividend yield for the full year of 22.1%.

In reality, will the final dividend lift the full-year yield to that eye-watering level? We don’t know. Commodity pricing remains highly volatile and that can lead to sharp dividend cuts as well as increases. That risk concerns me here whatever the yield turns out to be this year. Longer-term, if commodity prices collapse, not only will the dividend likely be cut heavily, the Rio Tinto share price could also fall heavily. For those reasons, I won’t add Rio Tinto to my portfolio at the moment.

Ferrexpo

Iron ore producer Ferrexpo (LSE: FXPO) paid out just under 73c in dividends per share last year. Given its current share price of £2.85, that would imply a yield of 19.0%. So far this year, the payout has been more modest but even if it stops at its current level – 39.6c – that would still equate to a double-digit yield for the full year of 10.3%.

I like the fact that the company’s iron ore pellet production is relatively consistent. It moves around to some extent, but it rarely slumps. The costs the company can sell such pellets for is more subject to the cyclical nature of the iron ore market, however. That is a significant risk to profits – and the dividend. Another risk is the company’s heavy reliance on Ukraine, where its mines are clustered on a single strip. That exposes it to significant political risk, which could hurt both revenues and profits. Its relative lack of diversification means Ferrexpo isn’t a fit for my portfolio, despite its high yield.

Income and Growth VCT

Double-digit yields exist among UK dividend shares outside of the mining sector. One area they pop up is venture capital trusts. These are a type of unit trust that typically specialises in providing venture capital to early stage growth companies.

One such share is Income and Growth (LSE: IGV). Last year it paid out 14p in dividends, which equates to a 15.1% yield at the current share price. So far this year the trust has paid an interim dividend of 5p. That is 40% higher than last year, so if the final dividend is also raised, the prospective yield could be even higher than 15.1%. But investment returns from the company’s holdings can arrive on fairly unpredictable timelines, if they materialise at all. That means that the dividend in the trust can move around a lot from one year to the next. Still, its management and proven capability of finding promising young companies in which to invest make me consider it as a possible option for my portfolio.

BHP

Another mining group with a double-digit yield is BHP (LSE: BHP). BHP currently yields 11.6%. That comprises an interim and a final dividend totalling $3.01. However, that is a big jump from the prior year, when the total was $1.20. At that dividend level, the implied yield at today’s BHP share price would be 4.7%. I still think that is an attractive dividend, and it is above the FTSE 100 average yield, although it is firmly in the single digits.

The dividend has moved around a fair bit: this year’s final dividend, for example, is close to four times the level of last year. But, like Rio Tinto, BHP is a long-established miner with extensively diversified operations worldwide. With miners like this, I think the buying opportunity for me is when they are near the bottom of the cycle. That is always hard to call, but with strong commodity pricing I don’t think it’s right now. I might consider BHP and Rio Tinto for my portfolio once commodity prices fall again in coming years, but not at the moment.

High street bank

Penny stocks aren’t necessarily obscure names with small capitalisations. One of my favourite UK penny stocks is a financial powerhouse with a market cap of £33bn.

Banking group Lloyds (LSE: LLOY) is so well-known it needs little introduction. The company owns brands including Bank of Scotland and Halifax, as well as its eponymous Lloyds fascia. Its shares have traded in pennies since 2008, when they were badly hit by the financial crisis. But lately the Lloyds share price has been increasing, adding 45% in the past year.

The bank has a well-established, widespread business with strong customer awareness. It is the largest mortgage lender in the UK. Even during the pandemic it turned a profit, albeit much reduced. It has restarted its dividend and has sufficient capital to pay a special dividend in future should it decide to do so.

I think the bank is a good proxy for the British economy at large, particularly the housing market. I am happy holding it in my ISA. However, its dependence on the UK economy could be a problem in a recession. And its heavy exposure to mortgage lending does point to a key issue. Any downturn in the housing market risks rising default levels among borrowers. That would likely reduce Lloyds’ profits.

UK penny stocks yielding over 6%

Income and Growth Trust (LSE: IGV) is a fund that tries to achieve capital growth while paying out dividends. It does that by investing in companies in their early stages that it thinks have strong growth potential. It tends to spread its bets quite widely, which mean that if some investments are duds, the overall impact on the trust is limited.

Sometimes IGV pays special dividends. Last year, for example, it paid out bumper dividends of 14p. Given its current share price of 91p, that is a sizeable payout. In other years the dividend is not as big. But even the smallest dividend in recent years – 6p – would equate to a yield of around 6.6% at the current IGV share price.

Dividends are never guaranteed, of course. One risk I see in IGV is the relatively illiquid nature of some of its holdings, which can make the share hard to value accurately.

Medical-focused property developer

I’d also consider Assura (LSE: AGR) on the list of UK penny stocks for my ISA.

Assura is a property developer. It focuses on properties for medical use, such as doctors’ surgeries and primary care buildings. Over the coming decades, I expect demand for such buildings to be relatively strong and foreseeable. Tenants such as health authorities and doctors’ practices are likely to pay their rent, even if the economy performs poorly, in my view.

With growth potential and a current dividend yield of 3.6%, I think Assura could fit well into my ISA. But one risk is the UK government’s willingness to suspend landlords’ rights. As seen during the pandemic, this can lead to long delays in collecting rent from even deep-pocketed tenants. That could hurt the cash flow of a landlord like Assura.

Income and growth

Often investors talk about income or growth stocks as if the two are mutually exclusive.

Among penny stocks, one that seeks to combine the best of both worlds is the Income & Growth Trust (LSE: IGV). This actively managed trust invests in a wide array of small and medium businesses in the UK. It aims to increase value over time through capital growth in those shareholdings. But it also targets income.

That sounds ambitious. But its track record impresses me. For example, last year it paid out 14p in dividends, even though it’s a penny stock. But as young businesses pay out dividends unpredictably, IGV’s own distributions aren’t smooth. So, for example, the couple of years before that, the annual payout was 6p. Still that’s a 7.5% yield on the current share price. As an investor with an eye for dividends, I find that highly agreeable.

Growth prospects

Growth also looks promising. The trust managers have a long record in picking companies. As they diversify across companies, they can afford some bad picks. But overall they have had some impressive successes. For example, the current top holding is in Virgin Wines. The holding is valued at approximately £8.0m, but the trust only paid £2.4m.

Investing in growth stage companies can be unpredictable. The company’s picks might not offer growth and indeed may not provide income in future. That is one reason the IGV dividends move around a fair bit.

Recovery story among penny stocks

One penny stock that has already soared lately is Lookers (LSE: LOOK). The car dealership chain is up 277% over the past year.

With that sort of growth, obviously there is a risk that the shares could run out of steam. But there is a reason for the strong performance. Previously, Lookers had been beaten down due to an accounting scandal. As details of a past fraud emerged in piecemeal fashion, the market feared the worst and the shares tanked.

New management, new auditors, a resolution of the accounting scandal, and a focus on recovery have combined to improve sentiment toward the share, which last year touched a low of 16p.

The company repeatedly emphasized last year that its property portfolio alone was worth 85p per share – less than the current share price.

Strong performance

As one of the biggest car dealers in the UK, Lookers is set to benefit from economic recovery. In a trading statement issued today, Lookers said that its first quarter trading performance was stronger than expected. It sold over 44,000 vehicles in the quarter, which I think suggests the company is no longer on the ropes.

There are risks. For example, working from home could lead to less demand for cars. The company’s historical accounting problems may have damaged its reputation, and the rise of electric cars could damage demand.

I like the shares though, and currently have a position in Lookers. I’m hoping they won’t stay penny stocks for too long!