Cash has been king for the past 18 months or so as investors have taken advantage of higher interest rates and locked in good returns in cash accounts.
For investors, this has also meant a return to fixed income, which struggled in 2022 but now appears to be on strong footing, as Pictet’s Jon Mawby told Emma Wallis this week.
Yet with interest rates likely to be on their way down this year, investors may start to return to the stock market for their income. While riskier, it presents a good opportunity to gain an income far higher than from cash and bonds.
The 10-year gilt currently offers investors an income of 4.07% per year, while the top easy access savings accounts are higher at 5.2%.
Yet there are some companies far exceeding this. At the top of the tree is cigarette maker British American Tobacco, which currently offers a 9.9% dividend yield, according to data from AJ Bell investment director Russ Mould.
It has dividend cover – how much it receives in earnings versus the amount it pays to shareholders – of 1.4x and has not cut its dividend in more than a decade.
“It can even point to a streak of increases in its annual dividend payment that stretches back to 1998,” Mould noted.
Insurance firm Phoenix Group is another with a 9.9% yield, although dividend cover is lower at 0.3x and it has a habit of lowering its dividend – doing so in both 2016 and 2018.
But there are a plethora of stocks with high income payouts. Asset manager M&G currently yields 9.4%, followed by fellow tobacconist Imperial Brands (8.7%) as well as financial juggernauts Legal and General (8.4%), HSBC (7.6%) and Aviva (7.1%).
However, investors need to keep in mind that investing directly in single stocks is much riskier than diversifying.
Furthermore, companies may be paying sky high yields because their share prices are cheap for a reason. An oft-used rule of thumb states “any dividend yield which exceeds the risk-free rate by a factor of two may turn out to be too good to be true”, Mould said.
“The 10-year gilt yield is a good proxy for the risk-free rate. A dozen years of interest rates at near zero rendered the rule pretty useless but now monetary policy is returning to something akin to ‘normal’ it may regain some of its former relevance.”
Taking British American Tobacco as an example, despite its long track record of upping dividends, the firm continues to face ongoing regulatory pressure.
“Investors should never take anything for granted. There have been 138 dividend cuts across the current crop of FTSE 100 members in the past decade and even if 74 of those came in the Covid-blighted years of 2019 and 2020 there were still nine in 2023,” said Mould.
Still, for those unwilling to take the risk on individual stocks, the FTSE 100’s forecast dividend yield of 3.8% for 2024 (and 4.1% for 2025) makes it an interesting option at a time when interest rates are expected to come down.
“Financial markets continue to price in three interest rate cuts of one-quarter of a percentage point apiece from the Bank of England by the end of 2024. That would take the base rate down to 4.5% and potentially weigh on UK government bond yields, to further raise the profile of the UK equity market’s income potential, at least if inflation stays relatively benign,” said Mould.
There are myriad factors to consider when investing for income, but now could be a chance for investors to put some of their cash into equities. Although it may be riskier, the prospect of capital gains and a strong starting yield mean they are a good option for the long term.
And as I wrote last week, those willing to explore further down the market capitalisation away from the FTSE 100 may be in line for even better yields in the future.