Best dividends for safety and growth revealed

Since major central banks began cutting interest rates in 2008, investors have been desperately searching for decent income from their investments. It's not been easy. And nowhere is that hunt for yield more evident than in the UK. Rates were at 5% when the financial crisis began, but within five months had shrunk to a record low of 0.5%. Most savings accounts still pay next to nothing, which is why dividend-paying equities remain incredibly popular.

A spectacular turnaround in corporate earnings post-2009 - the result of heavy cost-cutting and a return to economic growth in major global economies - left companies with pots of cash to fund bigger dividends. That growth went unchecked until 2013 and then last year, when sectors such as oil and supermarkets ran into trouble. Others, like the mining industry, look shaky, too, raising some concern about the sustainability of payouts. 

And, after a six-year bull run, many high-yielding stocks now look expensive, while those which appear to scream value do so with good reason. Even stocks with a reputation for safe dividends have shocked investors by cutting, or axing returns to shareholders - you know who you are Centrica, Tesco and Severn Trent. Rights issue fan Standard Chartered joined the list Tuesday. 

However, there are plenty of analysts queuing up to espouse the virtues of a crop of viable income stocks. We reported recently on the favourite "safe" dividend plays of UBS, and also on a 6.8% increase in dividends paid during the third quarter, according to Capita.

Matt Hudson, head of the business cycle team at Schroders, thinks UK dividend growth looks likely to accelerate again in 2015.  "This reacceleration is what you would expect as we move into the latter phases of the business cycle," he explains, "and we anticipate dividend growth returning to its 5-6% nominal long-term trend level this year and next".

Domestic banks are "one of the most interesting UK equity income prospects," adds Hudson, particularly Lloyds and Barclays. Higher interest rates are good for business and balance sheets are much stronger now, so fatter profits should mean bigger dividends. Lloyds currently offers a prospective yield of 5% for 2016 and 6.5% for the year after.

Flight to safety

However, there are not insignificant concerns about a possible downturn in 2016. The economic slowdown in China remains the biggest worry, and the strong dollar continues to damage emerging economies. Growth forecasts for both the US and Europe have been downgraded by the International Monetary Fund (IMF), too.

Thankfully, there are a number of companies which have not only paid dividends through thick and thin, but actually increased them time and again. That's not to guarantee they will do so in future, but their track record suggests this is as safe as equity dividend income gets. A quick glance at the table also reveals a stunning share price performance by most, rubbishing the assumption that to generate income investors must sacrifice capital growth.

As a starting point we've checked out the S&P UK Dividend Aristocrats index. It measures the performance of the highest dividend yielding UK companies included in the S&P Europe Broad Market Index (BMI). It tries to strike a balance between high dividend yield and sustainability and growth.

There are some obvious names in the top 10 of 30 constituents in the index, among them big payers such as GlaxoSmithKline and BHP Billiton.

A quick scan of the internet reveals drug major Glaxo has increased the dividend every year since at least 2003, and management has moved to quell doubts about the sustainability of income payments. At last week's third-quarter results it repeated its intention to pay an annual ordinary dividend of 80p for each of the next three years to 2017. There'll be a special payout of 20p a share next spring, too.

BHP is perhaps less certain. A killer 8% yield shouts "cut me", and the money might certainly be deployed better elsewhere, perhaps snapping up quality assets on the cheap. However, comments from chief executive Andrew Mackenzie in an analysts' briefing in August suggest otherwise. "'Over my dead body' sounds a little strong, but it is almost right," said Mackenzie when an analyst enquired about the chance of a cut.

Less obvious perhaps, are companies like engineer and nuclear expert Amec Foster Wheeler and outsourcer Mitie. The former has raised its divided each year since at least 1998 and the latter since at least 1999. Both have seen their share price rocket in that time, too.

Four more for the bottom drawer

Royal Dutch Shell is among the most reliable dividend payers in corporate history. It hasn’t cut the dividend since World War II and total dividends have shown compound growth of an inflation-busting 5% since 1989.

Yes, oil prices staying lower for longer is a problem, but Shell has sold billions of dollars worth of assets already and has earmarked a further $30 billion for sale between 2016 and 2018, after the BG acquisition goes through. It’s why the company has promised to pay $1.88 a share for 2015 and intends to cough up “at least” the same again next year.

It’s not the most generous payer, but smoke detectors and automatic door sensors firm Halma has grown the dividend by 5% or more for the past 36 years. And these returns are backed by the fundamentals. The year to March 2015 was also the twelfth successive year of record results.

Soap maker PZ Cussons has done even better. Last time round it hiked the dividend by 3.1% despite falling profits, the 42nd consecutive year of annual increases.

Business has been hit by everything from Ebola to a slowdown in emerging markets to a weak Nigerian currency. Pressure on exchange rates across emerging markets remains a problem, and low oil prices mean Nigeria has imposed foreign exchange restrictions on some imported goods.

Capita  is the share registrar for hundreds of companies and runs businesses and services on behalf of government, the NHS and corporates. It’s had a few hiccups over the years, but it’s always made enough to keep growing the dividend. Its record of payouts stretches back to the late 1980s, and the total dividend has grown at a compound annual rate of 12% over the five years to 31 December 2014.

Finding your own income stars

To find your own income generators, investors must be armed with a few key facts. First off, running a stock screen for the highest historic dividend yield is not sufficient. Companies do cut dividends, and what happened in the past is not necessarily an indicator of future behaviour. Search instead for the forecast dividend yield one year out. OK, the payout can still be cut, but at least some assumptions about future performance should be baked in.

Be wary, too, of the double-digit or high-single-figure yield. It can be a big warning signal, reflecting a plunging share price and conviction that the payout will be cut; but not always. A year ago, we covered companies which promised fat dividends, some approaching 10%, and most lived up to their billing.

To get an idea of dividend policy and the health of a company, always check out the most recent and relevant company announcements, or RNS (Regulatory News Service) statements. You get a good idea of whether management will keep their promise on the dividend. Look for a commitment to a particular level of payout, and whether the business can support it. A profits warning is an obvious sign of trouble, although does not always end in a dividend cut.

Research is crucial, then, but there are some key metrics to consider, too.

Check out a company's dividend cover. That reflects how many times the dividend could be paid out of available profits after tax. The City likes a figure of 2 or more, but above 1 still implies that the dividend is affordable without borrowing. Also look at the interest cover - the ratio of operating profit to interest charges. You'll want a read of 4 or more to feel comfortable.

Good luck.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.