A safer approach to high yields

Volatile market conditions tend to be easier to deal with for investors intent on squeezing high yields from their portfolios over the long term. In theory, it's easier to stomach price swings if you know that shares will pay a regular dividend, regardless of how the market values them on any given day.

Yet, income hunters currently face some challenging conditions. Some of the highest-yielding sectors are under pressure, leading to questions about the sustainability of payouts from some of the market's biggest dividend shares. So what should high yield investors do? 

It's a dog's life

To get a feel for the current climate for dividends, it's worth taking a quick look at the shares making it onto one of the most well-known income strategies around - Dividend Dogs. We regularly mention the strategy in this column because of its sheer simplicity and popularity. It's inspired by an approach used by American investment advisor Michael O'Higgins in his book Beating the Dow.

In the UK, the strategy buys a basket of 10 of the highest yielding stocks in the FTSE 100 index and holds them for one year. Its supposed safety net is that high yielding blue chip stocks tend to be mature, stable businesses. Unfortunately, in the UK market, they also tend to be found in some beaten up sectors like oil & gas, mining and supermarkets, to name a few.

For stockmarket investors, one option is to take a 'scientific' approach to finding potentially safer yieldsAs a result, Stockopedia's tracking of this strategy last year saw a 34.8% decline.

It was battered by holdings in the likes of Royal Dutch Shell, Glencore, Tesco, HSBC and Aberdeen Asset Management, among others.

Unfortunately, the outlook for some traditionally high yielding FTSE 100 giants remains far from clear. According to Capita Asset Services, which tracks dividend payouts in the UK, the expectation for 2016 payment levels has weakened significantly. Dividend cuts abound and the prospects for some high yield sectors like commodities are uncertain at best.

These problems are compounded by the fact that, in a low-rate environment, the alternative sources of returns are hardly attractive. So for stockmarket investors, one option is to take a more scientific approach to high yield and dig deeper into which dividends look - potentially - safer than others.

To do this, Stockopedia screened the market for Interactive Investor, focusing on high yield, financial strength and quality. The emphasis here is on balance sheet strength, as measured by the nine-point accountancy based checklist called the Piotroski F-Score. This is often used in determining the financial resilience of a business and, in this case, a signal of its ability to maintain and grow dividend payments.

We also included a Quality Rank for each company, which is a broad-brush assessment of its profitability, strength, financial quality and the absence of financial "red flags" - from zero (poor) to 100 (excellent).

The forecast yields on offer range from 4.1% at technology company Smiths to 5.9% at Barratt Developments. As well as Barratt, other housebuilders making the list are Persimmon and Bovis Homes. Fashion retailer Next is among the highest yielders at 5.7%, with healthcare and industrials firms including AstraZeneca, Mitie, easyJet and Stagecoach all on forecast yields over 4.5%.

Income safety

Rocky market conditions and pressure on some of Britain's biggest blue-chips have created unsettling conditions for income hunters. Payouts from some of the stalwart stocks of recent years may now be in doubt.

So for investors looking for high yield, or those concerned about the sustainability of payouts, a health check could be useful. Few companies relish the prospect of slashing payouts, but some have no choice.

For investors, spotting the problems early with some simple financial tests could help avoid disappointment.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson ofStockopedia.com, the rules-based stockmarket investing website. You canclick 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.

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.