When analysing dividend stocks, not only is it important to look for a high yield, but also to consider dividend sustainability and growth. By sustainability, I'm referring to whether the company can afford to pay its dividend and whether there's a chance of a cut in the future.
In relation to growth, ideally I like to see a pattern of consistent growth in the past and prospects for it going forward. A growing payout is considerably more valuable than a flat one as it means investors don't lose purchasing power to inflation. Today, I'm looking at both BP(LSE: BP) and J Sainsbury (LSE: SBRY) and examining their dividend prospects.
BP paid out 40 cents per share in dividends last year, which at the current share price and exchange rate is an appealing yield of 6.2%. While that's an attractive rate, especially in the current low interest rate environment, I'm not convinced that BP is an excellent dividend stock right now.
An examination of its dividend track record, reveals that the company has paid out the same 40 cents for three years now. Looking ahead, City analysts don't expect any growth this year or next. That's clearly not ideal from an income investing perspective. Inflation is currently running at around 2%-3% per year in the UK and that means the purchasing power of BP's dividend is diminishing over time.
Looking at the payout sustainability, the picture doesn't look great either. The oil price decline has taken its toll on profitability at BP in recent years. Analysts expect the oil major to generate earnings of 30 cents per share this year. That's a long way short of the expected payout of 40 cents, and not sustainable in the long term.
Having said that, BP has reduced its operating costs so that the oil price needed to cover its cash expenditures and pay the dividend is now just $49 per barrel. With oil prices hovering in the low $60s at present, the dividend looks sustainable, for now.
Overall however, I believe there are other better dividend stocks in the FTSE 100 right now.
Another dividend stock I wouldn't buy today is J Sainsbury. While the supermarket sector was once a fertile hunting ground for UK income investors, the landscape has changed considerably in recent years.
Indeed, the aggressive approach of the German discounters Aldi and Lidl has made life very difficult for the traditional UK supermarkets over the last five years. And this has been reflected in Sainsbury's profits and dividends. After paying out 17.30p in dividends in 2014, the supermarket has since paid its shareholders 13.2p, 12.1p and 10.2p. That's an ugly trend. Furthermore, in its most recent half-year results, released earlier this month, the group cut its interim dividend to 3.1p from 3.6p last year. City analysts expect a full-year payout of 9.8p, which is a yield of 4.3% at the current share price.
Its cash flow looks to be enough to cover the dividend payments. For the recent half year, dividends paid of £144m were covered 3.4 times by free cash flow. And dividend coverage is anticipated to be a healthy 1.9 times this year. However, despite these positives, again I believe there are better FTSE 100 choices out there.
Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has recommended BP. 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.