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High dividend stocks Strategy, consistency and dividend cover in United Utilities

InvestorEducation / Investing Dec 03, 2006 - 08:25 PM GMT

By: Shahla_Walayat


A portfolio of high dividend yielding stocks has consistently shown itself to outperform the broader market in the long-run and without the same degree of volatility associated with growth stocks. The strategy involves finding consistently high yielding stocks which provide an income of 5% or more on top of capital appreciation, this dividend is also likely to rise so as to maintain the yield on any gain in the share price, so as to maintain the Yield %.

The dividend yield is simply the total annual dividend divided by the current share price, which equals the dividend yield.

Taking a popular high yielding stock, United Utilities as an example - United Utilities is a British company that is listed both on the London Stock Exchange (LSE) and the New York Stock Exchange (NYSE). Its principal activities are managing and operating the regulated electricity distribution, water and wastewater networks in north west of England.

Investor Education - High dividend stocks Strategy, looking for consistency and dividend cover in United Utilities

Its current share price is $30.23 (NYSE), and the total annual dividend is 1.62 this results in a yield of 1.62 divided by 30.23 = 5.36%; on the LSE the current share price is 762p, and annual dividend of 42p resulting in a yield of 5.42%.

Is UU a good high dividend stock to buy today ?
One of the key tests in determining the answer is consistency in payment of a high dividend, as a stock can temporarily appear to be high yielding stock due to a fall in the share price which gives a false indication of future yield, as it is highly likely the dividend will be cut. I.e. profits warnings due to troubles in the market place.

In this case, looking back at the historic yield of dividends payments over the last 6 years, United Utilities has always provided a high dividend, which has been as high as 8%..

Dividends for financial years ending March 31st (UK, pence/share).
2006 - 44p
2005 - 45p
2004 - 44p
2003 - 47p
2002 - 47p
2001 - 46p

What the table above shows is a consistent dividend of about 45p, where the yield has fluctuated due to the rise or fall in the stock price, which has seen the yield above 8% and the low being the current yield of 5.4% due to a recent surge in the stock price. An analysis of dividend payments also shows little or no growth in the dividend in some 6 years ! So at best UU is expected to maintain a 45p to 47p dividend for the foreseeable future, so lacks future growth in dividends which is likely to constrain future growth in the share price, as if the stock does rise further, this will force the yield lower as there is not expectation of the company raising its dividend on a year on year basis.

Therefore United Utilities only partially passes the consistency test, what I would like to see in a stock is year on year growth in the dividend paid.

The Dividend Cover
This is the second important test when looking for a potentially high yielding stock. The dividend cover expresses the number of times dividends could have been paid from profits (EPS). i.e. if the dividend cover is 3, this means that the firm's profit attributable to shareholders was three times the amount of dividend paid out. The higher the dividend cover the better, as the company is more likely to maintain the dividend in future years even if profits drop. A low dividend cover, especially near 1, means the company will struggle to meet the dividend in the coming year. The type of company also needs to be taken into account i.e. a utilities company tends to have more stable profits so can be expected to maintain a dividend even on a low cover of say 1.2. But when the cover is at or below 1.0, then even for a utilities company that could mean a possible cut in dividends as the company cannot afford to maintain the dividend at current levels.

Going back to the example of United Utilities - Lets look back at the companies financial results over the last 6 years to see what the dividend cover has been for the years ending 31st March.

Year 2006 - EPS 24.2p - Dividend Paid 44p - Dividend Cover 0.55
Year 2005 - EPS 30.1p - Dividend Paid 45p - Dividend Cover 0.67
Year 2004 - EPS 54p - Dividend Paid 44p - Dividend Cover 1.22
Year 2003 - EPS 46p - Dividend Paid 47p - Dividend Cover 0.97
Year 2002 - EPS 47p - Dividend Paid 47p - Dividend Cover 1.00
Year 2001 - EPS 63p - Dividend Paid 46p - Dividend Cover 1.37

The above table should clearly be flashing major warning signs for holders of United Utilities ! As the dividend is unsustainable, this means that United Utilities share price is expected to under perform the sector and any news on a cut in dividend would lead to a sharp fall in the share price. The only way to rectify the situation would be for United Utilities to increase profits to back above those needed to cover the dividends paid by at least 1.0. On a dividend cover of 0.55 and a yield of 5.5% , United Utilities is overpriced. The reason for the current pricing is that the sector is buzzing with bid interest. But for those looking a high yielding stock for the long-term. United Utilities under its current level of profits is not the stock to select.

United Utilities is expected to announce its interim results in a few days, it is possible that this could include a cut in the dividend payment, unless profits have risen significantly.

In conclusion, just because a stock has a high yield today, does not mean it will be so in the future, look at the consistency of dividend payments and the Dividend cover for indicators of continuing payment of high dividends going into the future. The dividend should also increase year on year.

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(c) 2005-2006

Disclaimer - This Article / Analysis is provided for general information purposes only and not a solicitation or recommendation to enter into any market position, and you are reminded to seek independent professional advice before entering into any investments or trading positions.
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