UK dividend investors are a fortunate bunch as the FTSE 100 index is filled with high-yielding stocks. Indeed, almost a third of the stocks within it currently yield over 4%. Yet some dividend stocks are better than others. Many of the highest yielding companies right now, such as Royal Dutch Shell and GlaxoSmithKline, have struggled with profitability in recent years. That means we can't rule out dividend cuts in the near term.
Today, I'm revealing one of my top dividend stock picks for 2018. It ticks all the boxes - a high yield, ample coverage, strong dividend growth and a low valuation. The stock I'm referring to is Legal & General Group (LSE: LGEN). Here's why I'm bullish.
High dividend yield
Legal & General paid its shareholders 14.4p per share last year. At the current share price, that's an excellent yield of 5.3%. According to Stockopedia, that made the insurer the 10th highest yielding stock in the FTSE 100.
Now the thing with high-yielding stocks is that sometimes you have to be careful. A strong yield can often signal that the company is in trouble, and that a dividend cut is on the cards. Yet in Legal & General's case, this doesn't look to be the case. Here's why.
Investors often use the dividend coverage ratio to assess whether a company can afford to pay its dividend. This is calculated by dividing earnings by dividends. Ideally we want to see a ratio of around 2 times, but anything over 1.5 is generally fine. If the ratio is under 1.2, that's when we should be concerned.
In Legal & General's case, earnings last year were 22.2p per share. That gives a coverage ratio of 1.54, suggesting that the company could comfortably afford its distribution.
Another important indicator of dividend health is the growth of the payout. Turning back to Shell and Glaxo, neither company has increased its payout in recent years. That's a warning sign.
But Legal & General has recorded seven consecutive dividend increases now and has boosted its payout by 55% over the last three years. That's what you want as a dividend investor, as a rising dividend tends to put upwards pressure on the company's share price.
Analysts expect 6% growth for FY2017, taking the estimated payout to 15.2p per share.
Another reason I'm attracted to the stock is its low valuation. With analysts expecting earnings of 25.3p per share for the year just passed, the estimated P/E ratio is just 10.8. At a time when many FTSE 100 stocks are trading at lofty valuations, that valuation leaves a margin for error in my view.
Lastly, the company has significant operational momentum at present, announcing in December that it is on track for a record year of earnings and profits. Management said that the group remains "strategically well placed to deliver strong, attractive growth and returns" in its core markets.
Weighing up all these factors, Legal & General's dividend prospects look compelling. The stock is a 'buy' for me.
Edward Sheldon owns shares in Legal & General Group, Royal Dutch Shell and GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Royal Dutch Shell B. 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.