Finding top dividend stocks isn't easy. While there are plenty of stocks out there that yield 5% or more, a high yield usually indicates that the market does not believe the payout is sustainable.
However, there are hidden gems out there. Sometimes the market unfairly punishes a company without giving proper consideration to the fundamentals. Here are two stocks with a yield of 7% or more that I believe are reliable income buys.
Shares in Stagecoach(LSE: SGC) have been hit hard over the past 12 months due to concerns about the company's earnings potential. After it was stripped of its South West Trains rail franchise, the company revealed an 83% drop in pre-tax profits to £17.9m in the year ending April 29 as losses spiralled on its East Coast rail franchise.
This bad news has pushed the value of the company's shares down by 25% over the past 12 months and this decline has sent the company's dividend yield up to 7.4%.
It looks as if this payout is here to stay. Not only is the dividend distribution covered twice by earnings per share, which is always an appealing feature, but on a cash basis, it also looks as if the firm can continue with its current dividend policy.
For fiscal 2017, the company generated £232m in cash from operations and had a free cash flow before dividends of around £130m. In total, the dividend cost just under £70m for the full year, easily covered by free cash flow with room to spare.
Even though shares in Stagecoach have been hit by a spate of bad news this year, it looks to me as if the company's high single-digit dividend yield is here to stay.
Planning for growth
PayPoint(LSE: PAY) is not suffering from a lack of investor optimism. Instead, the business is suffering from a problem we'd all like to have: too much cash.
For the past five years, the company has reported a free cash flow of around £30m per annum before dividends. Dividends have usually been below this figure, so the group's cash balance has expanded, from £40m in 2013 to £53m for fiscal 2017 (despite a one-off special £80m dividend last year). There is no debt, and management reported that the cash balance had expanded to £57m at the end of H1 fiscal 2018.
Going forward, City analysts are expecting the company to ramp up cash returns. Last year the firm paid out 45p per share in regular dividends. For the year ending 31 March 2018, a distribution of 81p is projected. A similar payout is expected for the year ending 31 March 2019.
Based on these projections, shares in PayPoint currently yield 8.8%, more than double the market average of around 3.8%. Based on the company's strong cash generation, it looks as if the payouts are safe for the next few years and shares in PayPoint trade at a forward P/E of only 15.
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Dividend stocks are the perfect way to grow your wealth. Indeed, research has shown that over the long term, dividends account for half of equity returns.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK owns shares of PayPoint. The Motley Fool UK has recommended Stagecoach. 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.