You can get decent investing results by collecting dividends from high-yielding stocks and reinvesting them to compound your gains. However, that strategy only works well as long as the stocks you buy and hold have sustainable dividends.
Is the high dividend an attraction or a warning?
One of the dangers of high dividend yields is they sometimes occur because of difficulties in a firm's underlying business, which could lead to a dividend cut later. You don't want to be holding the shares of firms when they slash their dividends because the share price can plunge too, potentially wiping out years' worth of your gains from past dividend payments.
Is utility firm SSE's (LSE: SSE) 5%-plus dividend yield sustainable? Here's the recent financial record:
Year to March
Net cash from operations (£m)
Profit before tax (£m)
Adjusted earnings per share
Dividend per share
The dividend increased a modest 9.3% or so over the last four years. However, net cash from operations and earnings per share declined a little suggesting SSE struggled to keep raising the dividend every year over the period.
Big changes on the way
In May's outlook statement with the full-year results report, SSE said it "believes that its dividends should be sustainable, based on the quality and nature of its assets and operations, the earnings derived from them and the longer-term financial outlook." I couldn't agree more. However, the table makes the firm's dividend trajectory look unsustainable to me, so it's just as well that there are big changes on the way for the business.
During the final quarter of 2018, SSE will spin-off its energy supply and services business, which means the company will cease supplying energy and services directly to British households, instead, earning ongoing revenue, profits and cash flow just from the remaining network and wholesale businesses. With the high level of competition now present in the British retail energy market making it hard for firms to turn a profit from selling energy directly to customers, SSE's divestment plans seem to make sense. There will be one more dividend rise for the year to March 2019 to 97.5p per share and then the directors will trim the payout to 80p for the year after that, which they say "provides a sustainable basis for future dividend growth." Looking forward, SSE plans to raise the dividend from the rebased level to "at least keep pace with RPI inflation."
SSE's dividend sustainability score
Let's look at three different features to judge whether the company's dividend seems sustainable with each indicator scored out of a possible five points:
Dividend cover: adjusted earnings covered last year's dividend almost 1.3 times. 2/5
Cash flow: operating cash flow runs well above profits but is flat over the period. 4/5
Outlook and trading: recent trading has been lacklustre and the outlook is cautious. 2/5
Overall, I score SSE 8 out of 15, which makes me a little cautious about the sustainability of the firm's dividend, particularly with the uncertainty of the imminent big changes to its business model. However, I'm optimistic that the firm has decent future prospects from where we are now.
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Kevin Godbold has no position in any of the shares 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.