Dividends and safety frequently go together. But I reckon even a little short-term volatility in a dividend does not really damage the potential safety aspect, as it's long-term dividend reliability that really counts.
Cyclical can be safe
Look at Rio Tinto(LSE: RIO). Its dividend has been erratic this century, being cut in the mid 2000s as growth in China-led demand started to slow and over-supply forced prices down. But it's been a lot less volatile than the share price.
Over the last five years, the dividend has been doing nicely, but the shares have been up and down -- after slumping to around 1,600p in early 2016, the price is now back up to 3,330p.
If you'd bought in that dip, you'd have had an effective 2016 yield of around 8.5%. Even though it was cut from 2015, it was better than expected, and the firm returned further cash in the form of a share buyback. The share price over-reacted that year to the expected weaker dividend, so you could say that buying for the dividend has been less risky than buying for the share price.
What does the future hold for Rio Tinto? The dividend is still expected to be a little uneven, with a 6.7% yield forecast for this year, dropping to 5.1% in 2018. That's partly due to the firm's new policy of paying out around 40%-60% of underlying earnings (while total returns in 2016 amounted to 70%).
So dividend returns are likely to be cyclical, as is the nature of the mining business, but I reckon the real measure of safety is in a dividend's long-term prospects -- and I think Rio Tinto's looks good.
If we want something a bit closer to conventional safety, that is less short-term volatility, top insurer Legal & General(LSE: LGEN) fits the bill for me. The dividend was cut in 2008 and 2009 as a result of the financial services crisis, but compared to some others in the sector and to the carnage inflicted on the banks, Legal & General shareholders suffered relatively light pain.
Over the past five years the dividends have made a storming recovery, on the back of double-digit earnings per share rises year after year -- and there was a yield of almost 6% paid for 2016. Over the past 10 years, Legal & General shares have appreciated by 60%, and that spans the frantic years of the crunch too. And if that's the result of the worst panic to hit the industry in decades, it makes me think we perhaps shouldn't worry too much.
Having said that, the recent rapid earnings growth looks set to slow, with a couple of almost flat years expected, and we'd be seeing the forecast cover drop to around 1.4 times by 2018. I think that is getting close to the sustainable limit. However, with a yield of 6.6% forecast for 2018, there's plenty of safety room there in case of any future hardship. I'd personally see around 5% as a banker, with anything above that as a rainy day extra, and if I saw 5% as a long-term dividend average I'd be very happy.
These two shares are not unshakeable, but super-steady ones tend to offer low yields. And I think there's more than enough in the bigger yields here to provide long-term safety -- I'd much rather have a dividend varying from, say, 4%-7%, than a rock-steady 3% or 4% one.
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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has recommended Rio Tinto. 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.