The Risk of Chasing Yield
The ultra-low interest rate environment that we have been in over the last 7-8 years has forced investors to take on risk for ever diminishing returns; the draw of a yield over 6% can be too much for some and they take the income regarding less of the potential downside that exists for capital value.
I mentioned last week the risks that I see of possible dividend cuts for some of the large companies in the FTSE-100 as they try and sustain dividends in the face of falling earnings per share. This week I have been looking at this a little closer and focusing specifically on the highest yielding shares in the FTSE-100 and whether these yields are sustainable or potentially at risk.
Firstly here are the top fifteen firms in the FTSE-100 ranked by historical yield – as you can see the vast majority have been suffering in recent times with negative returns and substantial falls in value.
The next question is…..do any of these offer value given the price declines and potential income that is on offer? Looking at this group as a whole I have my doubts for the following reasons: –
- Dividend cover continues to decline
- 5 Year annualised Earnings Per Share Growth is well behind 5 Year annualised Dividend Growth
- Payout Ratios continue to rise, and in this group now stand at an all time high
- 8 out of the 15 (53%) have a payout ratio of over 80%
- 3 out of the 15 (20%) have a payout ratio of over 100%
- If earnings are not there to pay for the dividends the money is drawn from another source potentially weakening the balance sheet or increasing debt
Here is some graphical analysis that illustrates the above points.
I think the answer may be that for many of these shares that headline yield comes with far too much risk!