Big companies, fat yields

Some income-hungry investors may view the FTSE 100 as a security blanket when turning to equities while interest rates are at record lows. But those in the index of the largest companies trading in London by market cap have not been granted any special privileges and the risks they carry are as real as those for lower-profile businesses.

FTSE 100 members generate huge profits and cashflow needed to fund decent dividends. But it is important to put reputations aside and take a closer look at a company’s ability to continue generating sufficient cashflow to secure and increase future payments.

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Those doubting the need to do their homework into some of the country’s largest companies need to be reminded of Royal Bank of Scotland’s (RBS) woes. In 2007 the FTSE 100 member reported a £10.4 billion pre-tax profit, yet a year later approached the government for emergency funding due to its ATMs running dry after years of reckless lending and over-paying for acquisitions.

The same was true of BP (BP.). Its dividend was suspended in 2010 to pay for cleaning up an oil spill in the Gulf of Mexico.

Problems with FTSE 100 dividends are not historical. Emerging market-focused bank Standard Chartered’s (STAN) forecast 4.1% yield is 2.4 times covered by earnings. This is safely above our desired minimum dividend cover ratio yet there are murmurings that the payout will be cut due to huge write-downs in Korea hitting its capital levels.

Investors should not be lulled into believing FTSE 100 companies will be the highest growth yielders on the market. Those backing companies in the second tier of London’s largest companies, the FTSE 250, actually saw their dividends grow almost four times as much in the first quarter.

Payout growth increased 3.3% from FTSE 100 companies, compared to 12.9% by those in the FTSE 250, according to Capita’s (CPI) latest dividend monitor report. Exposure to the UK’s recovery funded their returns, while the FTSE 100 is more internationally focused. When looking at the pace of growth, it is important to consider inflation. Utility companies are very popular with investors because of their steady cashflow. Energy provider SSE (SSE) has increased its dividend every year since 1999. Its strategy is to raise the shareholder payout to at least match the Retail Prices Index (RPI) measure of inflation. (MD)

Old Mutual (OML) 195.5p

Market cap: £9.6 billion

Prospective DPS: 8.8p

Prospective EPS: 20.0p

Prospective yield: 4.5%

Life insurer Old Mutual (OML) is one of the highest yielding FTSE 100 companies offering a prospective 4.5%, or 8.8p a share. Consensus forecast returns rise to 5.1% next year. The £9.6 billion cap’s dividend is 2.3 times covered by forecast earnings and the firm enjoyed a solid first quarter where sales jumped 24% to £6.2 billion year-on-year. Pre-tax profits are expected to remain flat at £1.5 billion this year, before rising to £1.7 billion in 2015. Old Mutual has interests in Europe and the US as well as Asia and Africa, where it serves demand for investments, savings and protection products from a growing middle class. Indeed, it has £297.1 billion of assets and £1.4 billion cash with geographical diversify making it well positioned to grow. Those backing Old Mutual should get a chance to use a dividend reinvestment scheme. These are offered by stockbrokers to reinvest dividends on behalf of shareholders in predominantly FTSE 100 stocks due to their liquidity. Investors need to consider if this is a service worth paying if you only have a small holding, looking at the proportion of reinvestment fee to dividend payment. (MD)