Can you count on Centrica's (LON:CNA) high dividend yield?

The Economist wrote in the aftermath of the 2008 financial crash that the crisis had led to the largest number of dividend cuts and suspensions since the Great Depression of the 1930s.

Income investors were reminded of the fact that dividend payments are far from certain. This type of risk doesn’t go away. People just forget about it for a while. Then, before you know it, one of your “safe” companies has issued a profit warning and is cutting its dividend.

In the UK, 2018 was a terrific year for dividends but a bad one for share prices. This pushed yields to extraordinary heights. A very high yield is often a sign of trouble ahead, as investors know that company earnings can evaporate when the economy turns down.

One of the quickest ways to kick the tyres on your current dividend generators is to check the dividend cover (earnings per share divided by dividend per share). Dividend cover is the inverse of the dividend payout ratio. Dividend cover of two times or above is strong. Anything below one and a half times - as is the case for British Gas owner, Centrica (LON:CNA), should be stirring us to investigate in more detail.

Calculating Centrica’s dividend cover ratio 

Centrica's current 9.03% rolling dividend yield may look very enticing but it is important to remember that a low level of dividend cover means that even a small decline in earnings could consign your dividend payment to the scrap heap. With that in mind, let’s take a look at Centrica’s (LON:CNA) dividend cover.

We can get all the information we need to see if Centrica has an adequate level of dividend cover from the company’s StockReport. Centrica's reported earnings per share for FY18 were 3.23p and its FY18 dividend per share was 12p. 

Divide the former by the latter and we get a trailing twelve-month dividend cover for Centrica of 0.27. A figure below 1 should be considered as a potential red flag for a looming dividend cut as it means that the company cannot currently fund its dividend payments from its earnings. However, it may be worth taking a closer look at the dividend sustainability and safety to see if this is the impact of a one-off event, or a trend which is likely to persist. 

Income investing: what you need to know

For many investors, dividends are a vital part of their long-term strategy. That's why we have created a variety of income-focused stock screens, such as the Best Dividends Screen, to identify promising candidates for income portfolios. Take a look and see if any of the qualifying stocks might be worthy of further research.

If you’d like to discover more about dividend investing, you can read our free ebook: How to Make Money in Dividend Stocks.