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The growth rate of FTSE 100 (UKX) dividends has slowed in recent years, but there's no doubt that Britain's blue-chips will always account for the lion's share of payouts. There are various strategies designed to harvest these dividends, but they often come with drawbacks. However, with a few tweaks, one of the simplest and most popular high-yield strategies can be easily enhanced.
In 2016, dividend payouts from FTSE 100 companies totalled £72.9 billion. That compares to £9.9 billion from companies in the FTSE 250 (MCX) and £1.8 billion from everywhere else. So, it's no surprise that the top 100 shares are the ultimate hunting ground for income investors.
One of the classic strategies for targeting these companies is known as Dogs of the Dow. It's inspired by the work of Michael O'Higgins and John Downes in their book, Beating the Dow. It simply aims to buy the 10 highest yielding stocks in an index of leading shares - like the Dow Jones or the FTSE 100. The simplicity and effectiveness of this approach has proved to be a huge attraction to investors everywhere.
However, when you apply it to the UK, the Dogs strategy has always had its drawbacks. For a start, a focus on high current yields pays no attention to the fact that forecast yields - which are easily accessible - do vary. In other words, a yield that might be appealing today may not be appealing in a few months - and that can be a warning of trouble ahead.
Secondly, the bulk of dividends in the FTSE 100 have traditionally come from a group of stocks in just a few sectors. Buying the top 10 yielding shares in the index could leave an investor highly exposed to sector-specific trouble. You only need to see the pressure on dividends in recent years in sectors like energy, mining, banking and supermarkets to know the risks of over-concentration.
To counter these drawbacks to the conventional Dogs strategy, it's worth considering changing tack by focusing on forecast yields. A strategy tracked by Stockopedia that does just this has seen a capital gain of 25% over the past year, outpacing the 22.6% gain from the regular Dividend Dogs model.
And rather than just harvesting the highest forecast yielders, this week's list for Interactive Investor deliberately takes the top yielder from each of the 10 main economic sectors. This may mean cutting out high forecast yield companies, but crucial trade-off is that it spreads sector risk.
|Name||Mkt Cap £m||PE Ratio||Forecast Yield %||Forecast Div Cover||Sector|
|Taylor Wimpey||5,752||9.8||8.1||1.4||Consumer Cyclicals|
|Royal Dutch Shell||170,269||21.2||6.9||1.1||Energy|
|Direct Line Insurance||4,940||15.5||6.6||1.3||Financials|
|Imperial Brands||30,052||25.0||5.3||1.5||Consumer Defensives|
|Rio Tinto||60,573||12.8||5.2||1.7||Basic Materials|
|Micro Focus International||5,087||31.1||3.2||2.0||Technology|
Taking this diversified approach produces a median average forecast yield of 6.6%. Surprisingly, that's exactly the same average forecast yield you'd have got if you'd ignored diversification and just scooped the top ten forecast yielders from the FTSE 100.
With this approach, the top cyclical is the housebuilder Taylor Wimpey (TW.) on a forecast yield of 8.1% (the second in line would have been Barratt Developments (BDEV)). Next is the dividend stalwart Shell (RDSB) (which just beat BP (BP.) to take the lead for the Energy sector). And third is Direct Line Insurance (DLG), which leads for the Financials (with the runner up being Lloyds Banking (LLOY)). Rounding up the top five forecast yields from the list, SSE (SSE) leads for Utilities and Vodafone (VOD) takes top spot in Telecoms.
Dividends are a highly popular source of returns, particularly in a low interest rate environment. For UK investors, the FTSE 100 easily represents the deepest pool of income options, but there are risks.
Over-concentration in stocks and sectors can leave investors exposed to unexpected setbacks. The classic high yield Dividend Dogs strategy takes no account of these potential problems. Yet with a bit of tweaking it's possible to take the strategy and build a much more diversified approach without compromising on yields.
Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket 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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It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.
*No fee for publication is involved between Interactive Investor and Stockopedia for this column.
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"
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.
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