10 quality income stocks for risk averse investors

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10 quality income stocks for risk averse investors

The past 12 months have offered mixed fortunes for income investors. On the upside, 2017 was a record year for dividend payouts. In total, £94.4 billion found its way back to investors with the help of special dividends and much improved payouts from mining stocks. But on the downside there were a handful of dividend cancellations from stocks on previously decent yields. Among them were companies like Provident Financial (PFG), Capita (CPI) and of course Carillion (CLLN), which recently went bust.

Dividends are one of the most important sources of returns from stocks over the long-term. Yet dividend suspensions are a perennial hazard for anyone on the hunt for yield. The good news is that there are strategies that can help to mitigate the risk of getting caught in a dreaded dividend trap.

The landscape for UK dividends

We often explore the landscape for UK dividends in this column because the figures are a useful barometer of corporate health and optimism.

Last year's £94.4 billion payout was up 10.5% year-on-year, according to analysis by Link Asset Services. The impact of lower sterling flattered the figures early on, but it was really a resurgence in payouts from mining shares that drove up the numbers. Overall, there were dividend increases in 13 sectors, compared to just six that saw payouts fall.

As always in the UK, the vast bulk of dividend payments in 2017 came from a relatively small number of companies. The top 15 dividend paying shares accounted for three-fifths of all the dividends paid last year. The top five companies accounted for two-fifths of the total.

But there were still problems despite the record figures, with a number of companies having to trim their payouts of cancel them altogether. Provident Financial, the consumer lending group, where Neil Woodford is the largest shareholder, cancelled its dividend after a profit warning mid-year. Likewise, the now-bust outsourcing group Carillion was boasting a forecast yield of 10% shortly before its major profit warning last summer. Investors there have been wiped out.

It's precisely these kind of high profile disasters that has led to the creation of more safety-driven dividend strategies in recent years. One of them that we've mentioned here before is called Quality Income, which is a popular approach with some of the research teams at institutions like Societe Generale, Fidelity and Investec.

Putting dividend safety into practice

The simple idea behind Quality Income is that financially strong firms are less likely cut their dividend payouts. Typically, it avoids the very highest yields in the market, preferring more modest yields in financially strong firms with low bankruptcy risk.

For the average individual investor, there are host of possible metrics that can be used to measure financial health. It's a personal choice, but at Stockopedia we use the following rules:

● A yield of more than 4% (but less than 15%).

● A minimum market cap of £800 million.

● Each firm should pass at least seven of the nine checks in the Piotroski F-Score. The F-Score looks for improving trends in a company's profitability, debt, liquidity, share dilution and operating efficiency.

● No obvious risk of bankruptcy risk based on another accounting checklist called the Altman Z-Score.

● Financial stocks are excluded.

To get a broader view of each company's quality, we've also included Stockopedia's Quality Rank. This scores and ranks each company against a range of 'quality' measures and brings them together in a single number - the higher the better.

Name Mkt Cap £m Forecast Yield % (one year ahead) Piotroski F-Score Quality Rank Sector
SSE 13,188 7.5 7 65 Utilities
Barratt Developments 6,241 6.9 7 87 Consumer Cyclicals
BP 102,388 5.4 7 63 Energy
Royal Mail 4,648 5.3 8 91 Industrials
Persimmon 8,089 5.1 7 93 Consumer Cyclicals
Rio Tinto 70,975 4.8 7 81 Basic Materials
EVRAZ 5,513 4.7 8 71 Basic Materials
Berkeley 5,556 4.7 7 92 Consumer Cyclicals
Tate & Lyle 3,000 4.5 8 93 Consumer Defensives
BHP Billiton 85,178 4.3 9 97 Basic Materials


The results of this Quality Income approach very much pick up on the current trends in the market, with the buoyant mining and housebuilding sectors well covered.

Utilities group SSE (SSE) takes top position with a forecast yield of 7.5%. But among the miners, we see Rio Tinto (RIO), EVRAZ (EVR) and BHP Billiton (BLT), while the construction groups include Barratt Developments (BDEV), Persimmon (PSN) and Berkeley (BKG).

The high-profile dividend disasters that we've see over the past year are a reminder of how careful income hunters need to be when it comes to chasing high yield. Getting caught in a dividend trap not only means missing out on the payout but may also mean a loss of capital as the share price slides.

Taking a quality approach to income investing could help to mitigate these problems by targeting more modest yields in stocks with superior financial quality. For investors rattled by the dividend disasters last year but keen to benefit from the booming dividend landscape, a focus on quality could well be a good choice.

About Stockopedia

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.

Interactive Investor readers can enjoy a completely FREE 14-day trial of Stockopedia by clicking here.

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.

Ben HobsonAbout 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"

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