Like a lot of investors who find dividends an attractive passive income source, I am attracted to high yielders in the stock market. But often a high yield on dividend shares can act as a form of warning signal. It may be high because the market is pricing in a dividend cut, or perceives the company to be in existential danger.
In this article I’ll consider some common mistakes in hunting yield, and then look at some shares that currently have a double digit. I’ll consider whether buying them for my portfolio would meet my investment criteria.
Common yield-hunting mistakes
When looking for yield, like many investors, I have found that there are some simple errors that can trip me up.
One is paying too much attention to historical data. This is an easy mistake to make: after all, the only hard data one has on a company’s dividends is from its historical payouts. Any future dividend data is essentially just a forecast. Nonetheless, past dividends aren’t necessarily a guide to future payout levels. I find that can be particularly true when it comes to high yielders, as often a share’s high yield implicitly signals that the City is pencilling in a dividend cut.
Another common error is thinking of dividends as fairly static. For some shares, they are extremely dynamic. There can be many reasons for that: swings in commodity prices, shifting capital allocation priorities, and rules on what a company can pay out are just three. But it can mean, for example, that a company with a high yield pays great dividends for another year or two, then nothing for a decade, before later becoming a generous payer again (or not, in some cases).
Bearing in mind such common missteps, here are four double-digit yielding shares I could consider for my portfolio today. Only one of them appeals to me right now, for reasons I explain below.
Rio Tinto
Let’s start with the massive mining company Rio Tinto (LSE: RIO). Last year, Rio Tinto paid out a dividend of $5.57 (although it is listed in pounds in London, the dividend is paid in dollars). So far this year, it has paid $5.61 in dividends. That doesn’t include a final dividend so far. If the final dividend is increased as much as the interim dividend was, it would come in around $7.50. That would make for a total dividend this year of $13.11. At the current share price of around £44.04, that implies a massive prospective dividend yield for the full year of 22.1%.
In reality, will the final dividend lift the full-year yield to that eye-watering level? We don’t know. Commodity pricing remains highly volatile and that can lead to sharp dividend cuts as well as increases. That risk concerns me here whatever the yield turns out to be this year. Longer-term, if commodity prices collapse, not only will the dividend likely be cut heavily, the Rio Tinto share price could also fall heavily. For those reasons, I won’t add Rio Tinto to my portfolio at the moment.
Ferrexpo
Iron ore producer Ferrexpo (LSE: FXPO) paid out just under 73c in dividends per share last year. Given its current share price of £2.85, that would imply a yield of 19.0%. So far this year, the payout has been more modest but even if it stops at its current level – 39.6c – that would still equate to a double-digit yield for the full year of 10.3%.
I like the fact that the company’s iron ore pellet production is relatively consistent. It moves around to some extent, but it rarely slumps. The costs the company can sell such pellets for is more subject to the cyclical nature of the iron ore market, however. That is a significant risk to profits – and the dividend. Another risk is the company’s heavy reliance on Ukraine, where its mines are clustered on a single strip. That exposes it to significant political risk, which could hurt both revenues and profits. Its relative lack of diversification means Ferrexpo isn’t a fit for my portfolio, despite its high yield.
Income and Growth VCT
Double-digit yields exist among UK dividend shares outside of the mining sector. One area they pop up is venture capital trusts. These are a type of unit trust that typically specialises in providing venture capital to early stage growth companies.
One such share is Income and Growth (LSE: IGV). Last year it paid out 14p in dividends, which equates to a 15.1% yield at the current share price. So far this year the trust has paid an interim dividend of 5p. That is 40% higher than last year, so if the final dividend is also raised, the prospective yield could be even higher than 15.1%. But investment returns from the company’s holdings can arrive on fairly unpredictable timelines, if they materialise at all. That means that the dividend in the trust can move around a lot from one year to the next. Still, its management and proven capability of finding promising young companies in which to invest make me consider it as a possible option for my portfolio.
BHP
Another mining group with a double-digit yield is BHP (LSE: BHP). BHP currently yields 11.6%. That comprises an interim and a final dividend totalling $3.01. However, that is a big jump from the prior year, when the total was $1.20. At that dividend level, the implied yield at today’s BHP share price would be 4.7%. I still think that is an attractive dividend, and it is above the FTSE 100 average yield, although it is firmly in the single digits.
The dividend has moved around a fair bit: this year’s final dividend, for example, is close to four times the level of last year. But, like Rio Tinto, BHP is a long-established miner with extensively diversified operations worldwide. With miners like this, I think the buying opportunity for me is when they are near the bottom of the cycle. That is always hard to call, but with strong commodity pricing I don’t think it’s right now. I might consider BHP and Rio Tinto for my portfolio once commodity prices fall again in coming years, but not at the moment.