10 high-yielding big-caps with safest dividends

In the aftermath of the EU referendum result, there have been very few positive trends in the stockmarket. But one investing model that's so far managed to withstand the volatility happens to be one of the best-known income strategies around - dividend dogs.

To get a feel for why this strategy has worked and what it tells us, it's worth taking a look at how blue-chip stocks have performed recently.

A strong rebound in the value of the FTSE 100 since the EU vote has been hailed by some as a reason to be cheerful about the UK's economic outlook. But if you dig a bit deeper you'll find some well-defined winners and losers in the index.

Among the winners have been defensive sectors like consumer staples, healthcare and utilities. Others like mining and oil, which have limited exposure to the UK economy, have also done well. But cyclical, industrial and finance shares, many of which rely on buoyant consumer confidence, have been marked down sharply. A bright economic outlook? The market isn't so sure.

Dividend dogs bite back

One beneficiary of these recent trends is the dividend dogs strategy. The approach is based on work by an American investor and writer called Michael O'Higgins. It works by simply buying the highest-yielding shares in a blue-chip index like the FTSE 100.

Part of the thinking behind dividend dogs is that high yield is a proxy for relative cheapness. As a share price falls, its yield rises, all other factors being equal. So the strategy targets firms that might be near the bottom of the business cycle and have seen their prices fall as a result.

Given that these stocks are generally well-financed businesses with a well-established, robust dividend history, the strategy bets that the dividends will remain intact. And when the business cycle improves, the share prices should rebound quickly.

One idiosyncrasy with the strategy, however, is that it can result in a portfolio that's highly concentrated in certain sectors. For instance, if you'd picked the 10 highest yielding shares in the FTSE 100 at the start of 2016, you'd have a very high exposure to oil and mining. Stocks like Royal Dutch Shell, BP, Rio Tinto and BHP Billiton were all in there. In the recent conditions, this has worked in the strategy's favour, producing a 21.3% return this year.

Looking for reliable dividends

Despite this recent performance, one criticism of the dividend dogs strategy is that it doesn't take into account how "safe" a dividend might be. Dividend cuts are obviously hated by income investors and so the sustainability of payouts is crucial.

With that in mind, it's worth noting recent research which shows that the average level of dividend cover among FTSE stocks is falling. Dividend cover measures the amount of earnings that a company pays out in dividends. Consistently low cover can be a major pointer to potential dividend cuts.

As such, investors tend to look for a minimum dividend cover of 1.2x earnings, and preferably 2x or more. Yet, in aggregate, FTSE 350 companies last year paid out slightly more in dividends than they actually made in profits, making the dividend cover for the index just 0.98x.

Armed with these findings, we used this week's top 10 stocks to go looking for large-cap high yield shares with dividend cover of at least 1.5x earnings. They are picked from multiple sectors to avoid too much concentration.

Like the original dividend dogs approach, a search for large, high yielding companies can pick stocks on relatively depressed valuations. Many of these shares have been hit by the recent sell-off, particularly the likes of housebuilder Persimmon and airline easyJet.

By comparison, more defensive socks like National Grid have actually risen in price. Importantly, most of the shares here have dividend cover of more than 2x earnings, suggesting that their payouts are better placed to remain intact.

Despite the fierce market volatility in the wake of the EU referendum, some parts of the market have held up admirably. Defensive and commodity-focused sectors have performed well and this has proved to be a real boost to some high yield investing strategies like dividend dogs.

But before relying too much on this strategy it's worth considering the risks of too much sector exposure and potential dividend cuts from companies with falling earnings. A few safety improvements to an otherwise solid high yield strategy could add some much needed protection in uncertain times.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"