Dividend-led investing can be fraught with danger and thats why Im avoiding the big payouts available from HSBC Holdings (LSE: HSBA), Premier Farnell (LSE: PFL) and Esure Group (LSE: ESUR). Heres why:
At a share price of 505p, international banking giant HSBC Holdings forward dividend yield runs at around 6.6% and City analysts following the firm expect forward earnings to cover the payout about 1.6 times. That sounds tempting. However, the shares have slipped around 30% since the beginning of 2010, meaning capital loss has taken back investor gains from dividend payments.
HSBC Holdings is up against all the structural and regulatory issues facing other banks as well as volatility in its overseas markets. However, the biggest problem with a bank such as HSBC Holdings is its cyclicality. If the firm struggles to grow its business now during arguably benign macro-economic conditions, how will it fair when the next downturn arrives? It doesnt take a great stretch of the imagination to see the dividend axed, or trimmed back, and the share price 50% lower than it is today.
Banks come with so many hard-to-predict risks, and they are so cyclical, that avoiding them completely gives me a much better chance of achieving good stock-market returns.
When dividend yields get too high they tend to serve as a warning rather than an attraction, and thats what I see with FTSE250 constituent Premier Farnell. At todays 134p share price the firm expects to pay a 7.8% dividend yield relating to the 2016 trading year. That looks good at first sight, but forward earnings will likely cover the payout just 1.3 times, which suggests the firm could be struggling to pay the dividend, to me. Premier Farnell also finds it hard to grow the payout, which by next year will have been essentially flat for at least six years.
Earnings have been slipping for around five years. The firm describes itself as aglobal leader in the high service distribution of technology products and solutions. Judging by the companys financial performance that cant be an easy business to be in. Like HSBC Holdings, if the company cant thrive now while the macro-economic weather is mild whatever will happen when the next economic hoolie blows up?
Youve probably heard of Esure Groups brands such as Sheilas Wheels, Gocompare and Esure itself. The UK-focused personal insurer operates in the motor and home insurance markets, both of which are competitive to the point of being cutthroat.
Right now, Esures combined operating ratio runs around 96%, which means the firm makes underwriting profit (anything below 100% indicates that). However, the next insurance premium price war could be lurking just ahead. City analysts expect Esures earnings to decline 7% this year and to rebound by 5% during 2016. Thats uninspiring for what seems like something of a purple patch in the macro-economic landscape.
However, the biggest risk with Esure is that insurance firms tend to behave like other financials such as banks. They are cyclical, and we never know when the next profit, share price and dividend plunge will occur. Viewed like that, todays 6.1% forward dividend yield loses its shine. Forward earnings cover 2016s payout around 1.3 times, which makes the dividend look fragile given the challenges of the insurance sector.
HSBC Holdings, Premier Farnell and Esure Holdings dont cut it for me and Im not trusting their dividends.
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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.