The FTSE 100 is full of top dividend stocks, but some of these companies are better dividend buys than others.
Indeed, finding a top dividend stock requires more than just buying the share with the highest dividend yield. You have to be sure that the payout is sustainable, the last thing you want is to be on the receiving end of a dividend cut, which could wipe out years of income gains with capital losses in just a few seconds.
This is why I'm cautious of BAE Systems(LSE: BA) as an income investment.
Struggling for growth
Shares in BAE currently support a dividend yield of 4%, and the payout is covered twice by earnings per share. However, over the past five years, the company has struggled to grow earnings per share, and the dividend has been held back as a result.
For example, between 2012 and 2016, earnings per share ticked higher by only 4%. Analysts are expecting growth of 8% this year and management is guiding for an increase of 5% to 10%. This is a positive development, although I'd want to see a record of several years of growth like this before changing my mind on BAE's dividend capabilities.
As well as sluggish earnings growth, the company's pension deficit is also proving to be a headache. Today the company confirmed that it would increase payments into the schemes from about £205m a year to £220m from 2018 with payments rising in line with group dividends. Payments are scheduled to end in 2026 after the company has filled its £2.1bn pension hole.
For the fiscal year to the end of July, Go-Ahead Group (LSE: GOG) devoted £37m to topping up its pension schemes, a relatively minor sum compared to the group's £3.5bn in revenue for the period. This is just one of the reasons why I believe that as an income investment, it is a much better buy than BAE.
Shares in Go-Ahead support a dividend yield of 6.4% and trade at a forward P/E of only 9. BAE meanwhile trades at a forward P/E of 12.6. So, it is cheaper and offers a better level of income. The company also operates in a less regulated industry than BAE giving it more flexibility regarding investment and expansion.
Over the past five years, the group's earnings per share have risen from 118p to 219p allowing management to increase the dividend by 26%.
Over the past year or so, Go-Ahead has been hit by strikes at its key Southern Rail franchise, but now it looks as if these stoppages are behind it. Today it announced that after a relatively undisrupted summer, train revenues rose 2.5% despite a 1% fall in passenger journeys.
The update notes that thanks to this performance, the group is trading in line with City expectations, which indicates to me that the shares are worth more than their current discounted multiple.
Dividends are the key to success
Most investors don't realise that over the long run, dividend income accounts for around half of equity returns. With this being the case, you shouldn't overlook income stocks and if you do, you're making a big mistake.
Avoiding serious mistakes is the key to successful investing and to help you avoid falling into any investing pitfalls, the Motley Fool has put together this free report.
The report is a collection of Foolish wisdom, which should help you streamline your investment process and avoid those companies that might cost you money.
All you need to do to gain access is click here to download today.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.