Investing in high-yielding dividend stocks can be a good way to insulate yourself from the effects of short-term market corrections. However, it's important to try and choose companies with affordable and reliable dividends.
Shares offering a yield of about 5% can be ideal. This level of yield is high enough to be worthwhile, but is often low enough to be safe.
In this article I'll take a look three possible choices.
Motor insurer Admiral Group (LSE: ADM) released a solid set of results last week. Pre-tax profits rose by 6%, while earnings per share were 4% higher at 107.3p. Most importantly for us, the full-year dividend was hiked by 16% to 114.4p per share.
This gives Admiral a trailing yield of 5.8%. However, you may have noticed that last year's dividend was not covered by earnings per share. That's because, in addition to a large share of post-tax profits, Admiral was also able to return some surplus capital to shareholders.
This aspect of Admiral's dividend is common to many other insurance companies. It means that yields can be very high, but the payout will not always rise each year. Insurers also tend to be cyclical. Claims levels vary, and sometimes insurers are forced to cut prices or reduce their market share.
Despite these risks, Admiral has a track record of above-average shareholder returns. I believe the shares could be a good income buy.
Vodafone Group (LSE: VOD) currently offers a forecast dividend payout of 11.5p per share for the current financial year. This equates to an attractive yield of 5.3%. The only problem is that Vodafone is expected to report earnings per share of just 4.6p this year. The dividend won't be covered by earnings.
Vodafone's earnings are expected to rise to 5.7p per share next year, but the dividend will still be uncovered. When might this situation improve?
Vodafone has been spending heavily on network upgrades and acquisitions. However, this spending is nearly complete and Vodafone boss Vittorio Colao has promised that free cash flow and earnings should soon start to improve. He's also pledged to maintain the dividend.
Vodafone can afford to do this, as the group's debt levels are relatively low. The recent third-quarter results also suggest that earnings momentum is improving. I'm happy to continue holding my Vodafone shares for income.
Sales and profits have continued to rise at Telecom Plus (LSE: TEP), despite the 50% fall in its share price since January 2014. The group makes money by re-selling utilities and telecoms through its Utility Warehouse business. Adjusted earnings are expected to rise to 56.6p per share this year, giving a forecast P/E of 16.1.
Current forecasts suggest that the dividend will rise by 15% to 46p per share. This would give dividend cover of 1.2, which seems low. However, the firm's past results suggest that this payout should also be backed by free cash flow, making it relatively safe.
Analysts remain bullish on Telecoms Plus and are forecasting 9% growth for 2016/17.
Personally, I'm not sure how long growth can continue in the face of tougher competition from the utilities themselves. Any downturn in sales could trigger a longer-term decline in future cash flow, reducing the group's ability to pay dividends.
I'm unsure about Telecoms Plus, but believe Admiral and Vodafone could both be good income buys.
However, the Motley Fool's income experts ignored both of these stocks and chose a different firm for their new report, A Top Income Share From The Motley Fool.
The company featured in this report is a UK mid-cap firm with an attractive yield.
Decent capital gains could also be on the cards. The Fool's experts believe that profit margins could rise significantly over the next few years.
This report is completely FREE and without obligation.
To receive your copy today, just click here now.
Roland Head owns shares of Vodafone Group. 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.