The problem with dividends is that everybody loves them. Unfortunately, because everyone loves dividends when an attractive, sustainable looking high dividend yield appears, it doesn't take long for investors to flock to the opportunity pushing the payout down below the market average.
However, I've recently discovered two hidden dividend stocks that are both set to yield more than 8% this year and the payouts both look sustainable, but because you have to do some extra legwork to understand the payouts it seems the market is overlooking them.
Lancashire Holdings(LSE: LRE) is a difficult business to understand if you don't 'get' insurance. The company is a Lloyd's of London insurer, which can be a lucrative business when times are good. Luckily, times are good and in the past few years the insurance industry has recorded record levels of profitability as the number of catastrophes has slumped. What's more, with interest rates held at rock bottom levels, billions of dollars in additional capital has flowed into the sector seeking marginally higher returns. This extra capital has pushed down reinsurance rates, allowing insurers like Lancashire to offload risk to others.
With the above dynamics playing out, Lancashire's management has been able to release hundreds of millions from the insurer's reserves, and all of this unneeded capital has been returned to investors.
Lancashire only offers a token regular dividend payout, but once a year it pays out all excess profits via one large special dividend. Last year, the special payout amounted to 60p per share. This year, analysts have pencilled-in a total dividend for the year 52.2p for a yield of 8%.
Thanks to this dividend policy, since December 2005 shares in Lancashire have produced a total return of over 625% -- it's hard to disagree with these returns.
Over the past 12 months, shares in Next(LSE: NXT) have lost more than half of their value as investors have become increasingly concerned about the company's outlook against the backdrop of the hostile UK retail operating environment. Next's management is as cautious as investors, which can be no bad thing. Luckily, the group has spent millions developing its online offering, and this appears to be popular with customers. During 2016, while total sales for Next Retail declined by 2.9%, sales for Next Directory increased by 4.2% meaning overall group sales were broadly flat.
Like Lancashire, Next has a history of returning all excess cash to shareholders, and 2017 doesn't look as if it will be any different. Indeed, in the company's full-year 2016 results release, management projected it will return £225m to investors this year via ordinary dividends and £255m to investors via special dividends. With 145m shares in issue, these estimates imply the company will return £3.31 per share to investors this year. At the time of writing, this implies a yield of 8.1% for the year ahead on a share price of £41.10, almost double the published estimate of City analysts who appear to be excluding any special payouts.
On the road to a million
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Rupert Hargreaves owns shares of Lancashire Holdings and Next. 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.