10 best stocks for high-yield dividend investors

Dividend payouts from FTSE 100 shares rose by 17% in the first three months of this year. But with so many blue-chips declaring their payments in foreign currencies, nine-tenths of that growth was down to the impact of the weaker pound since last year's EU referendum. Read between the lines, and it turns out that dividend growth was actually quite weak.

By comparison, dividends from FTSE 250 companies rose by 11% in the first quarter. That's slightly lower than the growth from the blue-chips, but there's a crucial difference: while half of FTSE 250 revenues come from overseas, nine-tenths of their dividends are declared in sterling. So the impact of exchange rates is very small. What this tells us is that dividend growth among the mid-caps is holding up rather well in the current conditions.

The latest dividend data from Capita Asset Services shines a light on just how big an impact exchange rates can have on dividends. Indeed, while sterling's devaluation has been a useful boost, it's a sugar rush that could soon wear off.

Without further growth in earnings - which is usually the main driver of dividend increases - dividend growth could grind to a halt later this year. That means it's vital for income investors to pay close attention to whether eye-catching dividends are really sustainable.

What goes up might come down

Capita's figures show that UK payouts rose to £15.4 billion in the first quarter. That was up by 9.5% on the same period in 2016. Stripping out the impact of special dividends, which fell to a six-year low, dividend growth came in at a record 16.2%.

During the average year, a little over two-fifths of overall UK dividends are declared in foreign currencies. But between January and March, the weighting actually rises to three-fifths of the total payout. As a result, the impact of the lower pound added £1.7 billion to the total payout in - or 12 percentage points on the headline growth rate. Another 3.5 percentage points was down to a huge rise in the dividend from the mining giant, BHP Billiton. Without these two factors, underlying dividends would have actually fallen year-on-year.

Looking ahead, there are concerns that the impact of weaker sterling will wear off by the third quarter if exchange rates remain the same. But Capita does stress that improving global growth could spur improvements in company earnings. In the meantime, dividend growth among the mid-caps is expected to continue to outperform the large-caps on a constant currency basis.

A focus on dividend quality

To tackle the uncertainty around dividends, one option for investors is to focus on quality income. It's a strategy designed with caution in mind. It avoids the very highest (potentially risky) yields and instead targets financial quality. It looks for large, high quality firms in robust financial shape, which offer decent yields.

To meet the rules of the strategy, companies must pass at least seven of the nine checks in the Piotroski F-Score. This looks for improving trends in a company's profitability, debt, liquidity, share dilution and operating efficiency. It also checks for any risk that a company might go bust by using another accounting checklist called the Altman Z-Score. Financial stocks are excluded and the yields need to fall between 4% and 15%.

A strategy based on these rules, tracked by Stockopedia, has produced a 10% return over the past six months, before dividends, and 9.4% annualised.

The strategy offers some ideas about where reasonably high yields from good quality companies can be found right now. The forecast yields on offer range from 4.3% to 7.1%, with housebuilders being a common theme. Among them are Taylor Wimpey, Galliford Try, Berkeley and Persimmon. Others include the mining giants Rio Tinto and Anglo American, and household names like Royal Mail and the holiday company, Tui. 888 Holdings and Telecom Plus are two of the smaller FTSE 250 stocks also making the list.

A safer dividend approach

The tumble in the value of sterling since last summer has jet propelled some UK dividends at a time when underlying figures suggest that payout growth is stalling. To keep this growth on track, corporate earnings need to rise or the value of sterling needs to fall further.

Under that cloud of uncertainty, investors searching for sustainable dividends could consider a Quality Income approach. It's a strategy that prioritises financial strength in an effort to find sustainable payouts and could offer useful ideas at a time when reliable dividends are highly desirable.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stock market investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

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About the author

Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook".

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.