I like a good dividend just as much as many other investors. In this regard, the UK market can be more attractive than its US cousin. Even some blue-chip FTSE 100 and FTSE 250 shares have seriously high dividend yields.
Why is that?
Reduced earnings prospects
One reason can be that a company expects to do less well in future than it is now.
That helps to explain why FTSE 100 tobacco shares Imperial Brands and British American Tobacco both yield well above the index’s average of 3.0%, at 5.6% and 5.7% respectively.
Falling cigarette sales volumes could hurt sales revenues and profits. Indeed, both companies have reported declining total revenues for the past several years in a row.
Shunned sectors
Sometimes, investors shun a certain business sector. With fewer buyers for the shares, that can help sustain high yields.
For the tobacco companies above that might be on ethical grounds.
Other investors may shun what they perceive as “sin stocks” like alcohol makers. For example, personally I do not care to invest in companies that manufacture arms for global sale.
But sectors might also be shunned for non-ethical reasons. Sometimes, they just fall out of fashion.
Most of the highest-yielding FTSE 250 shares right now – like Bluefield Solar Income Fund with its 11.1% yield – are in the renewable energy business.
Investors have cooled on the whole sector, share prices have fallen (Bluefield Solar Income Fund is 36% lower than five years ago) and dividend yields have been pushed up.
Cyclical businesses
That can happen in cyclical sectors too.
For now it is too early to say whether the downturn in renewable energy performance is permanent, or part of a business cycle.
But we know many sectors are cyclical. Oil and mining may be doing well right now, but not all cyclical sectors are.
Take housebuilders as an example. FTSE 100 member Barratt Redrow yields 6.0%. It has already cut its interim dividend this year.
In good times, cyclical industries can see shares soar. On the way down – as we are currently seeing with UK housebuilders – weakening performance can lead to share prices tumbling.
That can push up yields, but often that is partly because the City expects a dividend cut sooner or later.
Mixed business messages
Another situation even in a non-cyclical industry can be when a successful company runs into trouble and is undergoing a turnaround.
Case in point: Pets at Home (LSE: PETS).
The FTSE 250 share is down by over half in five years, pushing its dividend yield up to 7.2%, although a change in payout policy means lower dividends are likely in future.
Could this be a reflection of reduced earnings prospects, like I mentioned above?
Its industry may be resilient, but the firm’s shops have struggled to maintain sales levels.
The second half of last year did see sales volumes grow year on year. But it is unclear that revenues are also growing.
I see a risk that the company may increase discounting, helping sales volumes but hurting profit margins.
However, I perceive the strong brand, large customer base, and retail turnaround plan as reasons to be optimistic.
The company’s vet practice division continues to grow well. I think this is a share for investors to consider.
