12 stocks for dividend investors hunting for high yields

After disappearing fast during the pandemic, dividends are back and offering investors potentially significant income opportunities. Analyst Ben Hobson screens the markets for a dozen of the biggest dividend yields around.

It’s undeniable that inflationary pressures and rising interest rates have dampened spirits in the stock market in 2022. After years of steady-as-she-goes conditions, investors are having to think much harder about how companies will fare in the future. It’s a painful adjustment, with share prices coming under pressure everywhere.

But one positive consequence of all this turmoil is that dividends are holding up well in many places, and the yields on some stocks are well above their longer-term averages. For those with an eye for income, this could actually be an opportunity.

Dividends bouncing back

Britain’s dividend landscape has changed dramatically over the past couple of years. In 2019, annual cash payouts hit an all-time record of just over £110 billion. But no one could have anticipated what would come next. Covid-driven lockdowns threw businesses and consumers into chaos. Dividends were the first cost to be cut as firms rushed to protect their finances.

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In the aftermath of the pandemic we’ve seen some positive early signs. Dividends have been recovering. After slumping to just £62 billion during the eye of the storm in 2020, payouts were back at around £94 billion last year. Mining and oil & gas sector payouts have been the highlight, soaring as a result of rising commodity and energy prices. But even payouts in more cyclical sectors such as retail and house construction have been on the up.

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At the market level, widespread dividend growth can be a barometer of broad, improving economic health. But just as importantly, rising payouts are very desirable in a phase of high and rising inflation. With the spending power of cash under pressure, one of the only ways to outpace that dragging effect is for companies to grow their dividends as proportionately as they can.

But inflation-busting dividend growth, of course, is not easy for companies dealing with disrupted supply chains, rising energy prices and war in Ukraine. They can either pass on these higher costs to customers or try to absorb them. Higher-quality, more resilient businesses will naturally manage this better - and that’s something income investors need to consider.

Yields on the move

It’s not just dividend growth that’s the big news for income investors at the moment. With heightened uncertainty pushing down share prices across the market, dividend yields in some areas are now well above average levels. If you believe that those payouts are sustainable, there’s a case to say that dividends are on sale at the moment. But buyer beware.

In more normal times, an unusually high yield can be interpreted as a red flag that the market is uncertain about whether a dividend is safe. This can be dangerous territory for the unwary investor, lured into a trap by the eye-catching yield.

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Remember that back in the summer of 2008, shares in Lloyds (LSE:LLOY) came with a stunning yield of 11%. Within 18 months, that yield momentarily spiked before collapsing as the financial crisis unfolded. Lloyds cancelled its payout and didn't resume it again for another six years.

To avoid the risks of a yield trap like this, it’s worth bearing in mind some dividend basics when it comes to screening the market. With this screen I have looked for shares with:

• A market capitalisation of more than £1 billion (because mid- and large-cap companies tend to be more financially resilient)
• A dividend yield of between 6% and 12% (above the market average but not unrealistic)
• A dividend coverage ratio of more than 1x (representing the number of times the dividend could theoretically be paid from the company’s cash from operations)

The screen also shows:

• The five-year average dividend yield (as a comparison versus the current yield)
• Year-on-year dividend growth for each share as a guide to the direction of recent payout growth

Source: Investing.com / InvestingPro

Not all companies have hiked their dividends year-on-year, but some rises have reached triple figures as firms get back to normal. Most are very well covered by earnings.

This list is led by Direct Line Insurance (LSE:DLG), where a recent profit warning saw its share price fall and its yield rise to one of the highest in the UK market. It’s a perfect example of the caution needed by investors, although in this case the company and its analysts seem to think the dividend is safe. Fellow financial group M&G (LSE:MNG) and a number of more tech-oriented names such as Vodafone (LSE:VOD), Micro Focus (LSE:MCRO) and Moneysupermarketn(LSE:MONY) are all on current yields above their five-year averages.

Among the housebuilders, Barratt Developments (LSE:BDEV) and Vistry (LSE:VTY) are also yielding higher than average, although Taylor Wimpey (LSE:TW.) is currently yielding below its longer-term norm.

It’s the same with the tobacco shares: Imperial Brands (LSE:IMB) and British American Tobacco (LSE:BATS) are on lower yields than usual. Part of the reason is that their one-year share prices have actually been positive, which has slightly depressed their yields.

Handle high yield with care

After such a chaotic couple of years for dividends, it is promising that payout growth has resumed. But faced with rising inflation and the potential for recession, investors now have different challenges. The market sell-off has pushed yields higher in many areas, but the risks facing businesses have risen too. In the hunt for what could be momentary opportunities to grab high yields, it will pay to handle them with care.

Ben Hobson is a freelance contributor and not a direct employee of interactive investor.