Disastrous profit warnings are rare in FTSE 100 companies. Yet the recent price collapse at consumer finance group Provident Financial showed that they’re not immune. Announcing a barrage of bad news, Provident cancelled its interim dividend and said its full year payout was unlikely. For a £2.6 billion stock with a yield of 7.7 percent, this was bad news for income investors and a reminder of how much care is needed with high yield strategies.
Yield is understandably one of the most important considerations for income investors. It’s the go-to measure of how much bang-for-your-buck a stock will give in terms of dividend payouts against the price paid for its shares. The higher the yield, the bigger the attraction - but there’s a catch…
Very high yield is one of the biggest warnings of a vulnerable dividend. Exceptionally high yields are often found in shares that have been marked down by the market. A tumbling share price will naturally drive up the yield on a share. But if that falling price reflects concern about the company’s future earnings, then it could be that the dividend is at risk. For the unwary, the high yield lures them into a dividend trap.
From this point of view, Provident did show signs of being a dividend trap. Analysts had been cutting their earnings forecasts aggressively since the spring and the company warned in June that it was likely to miss profit targets. In the latest warning, the profit outlook was slashed because of ongoing operational problems.
But while some voiced concerns about Provident, others felt the problems were overblown. The fund manager Neil Woodford argued that its difficulties were short term and that the dividend was ‘unlikely to be affected’. He still supports the company. But more broadly, it’s likely that the trailing yield of 7.7 percent (8.2 percent forecast) was enough for many to overlook Provident’s problems.
Indeed, while high yield can point to concerns, it’s also the cornerstone of one of the most popular dividend strategies around - Dividend Dogs. Provident had been a member of this exclusive club of shares in recent months, so it was likely to be on the radar of income investors. But it ended up showing how vulnerable the strategy is to problems.
Understanding the risks of Dividend Dogs
Dividend Dogs are the highest yielding large-caps in the market. It…
