Rushing out to buy the stocks with the highest dividend yields available is a risky game. Indeed, chasing yield can end up costing you more than you stand to make, although most of the time its almost impossible to tell which companies are most likely to cut their dividends.
To try and help investors from cashing unsustainable dividend yield, investment bankSocit Gnrale publishes a monthly list of high dividend risk companies across developed markets.
Firms that make it onto the list have a dividend yield of 4% or more and a lower-than-average Merton score a measure of credit risk and financial stability. This monthPremier Farnell (LSE: PFL) and Glencore (LSE: GLEN) top the list, while Fresnillo (LSE: FRES) tops the banks list of the most overvalued UK companies.
Dividend jeopardy
Premier Farnell supports a dividend yield of around 8% at present and trades at a forward P/E of 9.5. Traditionally, Premier has paid out the majority of its profits to shareholders. The companys dividend cover ratio has averaged 1.2 for the past five years. Nevertheless, Premiers earnings have collapsed by around 40% since 2012 andmanagement issued another profit warning during June. As Premier restructures to improve profitability, management could be forced to axe the dividend to save cash.
Glencore is under severe pressure to slash its dividend payout and key the cash for debt repayments. City analysts are becoming extremely concerned about the companys $50bn debt pile. If commodity prices dont recover soon, Glencore could find itself being forced to sell off assets to repay creditors. Even though Glencores dividend yield of 9% may be the best in the FTSE 100, it should be avoided it might not be around for long!
Socit Gnrale believes thatFresnillo should be avoided as it is one of the most overvalued companies trading on the London market. The company currently trades at a forward P/E of 55, making it one of the most expensive companies in the metals and mining sector. Whats more, Fresnillo also looks expensive on price to sales, price to book andEV to EBITDA ratios.
Dividend champions
Investors should avoidPremier, Glencore and Fresnillo. But Socit Gnrale believes thatPersimmon (LSE: PSN) andPearson (LSE: PSON) are two of Londons best income stocks. Using a similar method to the high dividend risk screen mentioned above,Socit Gnrales models show that Pearson and Persimmons dividend yields are well covered by earnings and the two companies have solid balance sheets, which can withstand sudden shocks.
According to City forecasts, Persimmons shares will support a yield of 5.3% next year, and the payout will be covered 1.5 times by earnings per share. Pearson currently supports a yield of 4.9%.
Moreover, both companies have cash-rich balance sheets with low levels of gearing. Pearsons net gearing is 42%, and Persimmon has a net cash balance of 272m.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.