FTSE 350 income screen: opportunities for market-beating yield

There’s no doubt that one of the defining features of the UK stock market today when compared to the US is the high dividend yield available from many UK stocks.

In a recent piece, I looked at the potential appeal and recent outperformance of stocks selected from the classic Dividend Dogs high yield screen. Having underperformed during the zero interest rate era, this screen has handily outperformed since rates started to rise.

As a follow-up to this, I decided to create a new simple FTSE 350 income screen to use as a source of ideas for big-cap income stocks. 

This piece will introduce the screen and highlight some of the higher yield opportunities I can see today among larger UK stocks.

In a second piece, I’ll then look at an alternative opportunity set in dividend growth stocks.

Finally, I’m planning to take a look at how to manage the balance between dividend growth and high yield in order to try and maximise returns.

FTSE 350 Income screen

I’ve named this screen the FTSE 350 Income screen, but have also specified a minimum market cap of £1bn. Although this excludes some FTSE 250 stocks, I think it’s useful for the purposes of this screen to ensure I focus on large, liquid companies with good analyst coverage.

The screen itself is extremely simple, by design. I’ve co-opted the StockRanks to do the heavy lifting alongside a few simple measures to narrow down the market to a plausible choice of high yielders.

Here’s a snapshot of the rules I’ve used:

(You can see the FTSE 350 Income Screen here)

Dividend yield: I’ve opted for a yield of at least 4% to ensure it’s above the FTSE 100 average (currently about 3.6%) and also high enough to be competitive with the interest rates available on savings.

Although dividends are never guaranteed and share prices can fall, I think that a diversified portfolio of FTSE 350 income stocks has the potential to provide similar income to savings plus medium-term capital gains.

Dividend cover compares the shareholder payout with earnings and is a useful measure of sustainability. Cover of 1.2 is relatively low for some businesses, but I’ve set the threshold at this level to include high yield companies that can legitimately afford to distribute most of their earnings each year.

StockRank >= 50: I use the StockRanks to layer in a wider range of quality, value and momentum measures. This allows me to keep the screen simple, while still tipping the balance towards shares that are more likely to perform well.

Sort by StockRank: I think it makes sense to sort the results of this screen by StockRank in order to bring the stocks with the most favourable profiles to the top of the list.

While the StockRanks aren’t intended as a stock picking tool, portfolios of higher-ranked stocks have historically outperformed lower-ranked stocks.

Stocks to consider

At the time of writing, 45 stocks qualify for the screen. That’s too many to sensibly picture here, but here’s a snapshot of those with a StockRank of 90 or more to provide a flavour of what’s on offer:

It’s worth noting that the sectors which dominate these screen results are likely to rotate over time, depending on economic conditions, commodity prices and other external factors.

For the remainder of this piece, I’ve selected three stocks for a closer look and highlighted a couple of others as possible alternatives.

IG group (LON:IGG)

This financial trading group will be familiar to many subscribers. I’ve been a client in the past and am also a long-term shareholder. Stockopedia’s algorithms style the shares as a Super Stock, with a particularly high scores for Quality and Momentum:

IG is the market leader by a comfortable margin, but I think there’s been some complacency in the face of growing competition in recent years. As it markets leveraged products to consumers, there will always be regulatory risks too. 

However, IG’s core leveraged trading business is hugely profitable and cash generative, while the group’s scale and reliability is appreciated by higher-quality (higher value) customers. My sums suggest that client churn is much lower than at Plus500 (LON:PLUS), for example.

The group has also been a big beneficiary of higher interest rates and is expanding in the potentially lucrative US market, particularly through its ownership of option trading business tastytrade.

Quality metrics are exceptional:

IG Group shares offer a forecast yield of 5.3% that should be twice covered by earnings this year. I don’t see much risk to this and believe there’s an opportunity for growth if the newish CEO can deliver on his plans.

In a similar vein, I might consider highly-ranked City broker TP Icap (LON:TCAP) (6.1% yield), which I covered in the Daily Stock Market Report earlier this week.

Dunelm (LON:DNLM)

Homewares retailer Dunelm is a familiar name around the UK and also boasts exceptional quality metrics:

Like IG Group, Dunelm is also viewed by the StockRanks as scoring particularly well for Quality and Momentum – a potential high flyer?

The founding Adderley family remain the largest shareholders and I think this is probably reflected in an excellent track record of ordinary and special dividends, rather than buybacks.

Dividends paid over the last 12 months have provided a 7% yield at the current share price:

Next (LON:NXT) is often cited as the top quality listed retailer in the UK and I wouldn’t argue with the excellence of that business. But I think Dunelm is a close rival for long-term shareholder value creation and I prefer its focus on dividends over buybacks.

Dunelm vs Next 10-year chart

Dunelm says it currently has a 7.7% market share in the homewares and furniture markets and is targeting 10% “in the medium term”. If this is achievable it means the business could still grow by another 30% or so.

Consumer sentiment is said to be muted at the moment. The company is presumably likely to face some impact from higher minimum wage and National Insurance costs next year. But the business has a clear strategy and its first-quarter update in October showed growth in volumes and an improved gross margin. 

While the stock’s P/E of 15 may seem high for a retailer, I think Dunelm’s high returns on equity and 5% yield mean this could be a fair price.

Pets at Home (LON:PETS) also appears in the screen results and would be an interesting alternative to consider, with a remarkable 24% share of the UK pet care market!

Aviva (LON:AV.)

FTSE 100 general insurer Aviva is a perennial high-yield favourite, but the stock has not always delivered on its promise as an income play. Dividends have sometimes been cut and the share price today is roughly where it was 16 years ago.

However, I believe this is a more cohesive and healthier business than in the past, thanks to the progress made by CEO Amanda Blanc since 2020.

Return on equity is now consistently in double digits, core units of the business are delivering growth and the dividend is covered by cash, with decent visibility. Debt leverage has fallen and the group’s capital position looks healthy to me.

I think it’s also worth remembering that Aviva’s 8% dividend yield is in line with the long-term average return from the UK stock market. This means that the shares would not need to rise much to give a total return ahead of the long-term market average.

I see Aviva as a sensible option for a reliable high yield.

Disclosure: Roland owned shares in IG Group Holdings, TP ICAP and Dunelm at the time of publication.