The Income Investor: an appealing cyclical dividend stock

Obtaining a dependable long-term income may be more difficult than it first appears. Falling interest rates, for example, can ultimately lead to a diminishing income return from cash. Indeed, in the years following the global financial crisis, savers received a paltry return on their cash balances as the Bank of England sought to stimulate economic growth via monetary policy easing.

Income received from bonds is also subject to an element of risk. Corporate bonds may fail to pay their coupons in some instances if operating conditions are challenging. Even government bonds may not necessarily be risk-free, with some governments having historically defaulted on their debt.

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Of course, dividends are widely regarded as being even less dependable than the income received from cash or bonds. After all, they are based on company profits that, in turn, can be highly volatile depending on a firm’s trading conditions and the wider economy’s performance. Furthermore, it is far more palatable for a company to cut dividends than miss its coupon payments should its financial performance come under pressure.

Relatively dependable dividends?

Despite the inherent risk of dividends, income investors should not summarily discount them. After all, some dividends are more reliable than others. Defensive stocks that are less dependent on the economy’s performance than cyclical firms can produce relatively consistent dividend growth over a sustained period. Moreover, their shareholder payouts may be less susceptible to being cut, given that the company’s profits are not materially affected by the economic cycle.

Mature companies may also offer more reliable dividends than their younger peers. They may consistently prioritise shareholder payouts over reinvestment due to a lack of appealing growth opportunities. Likewise, larger companies that are geographically diversified and have stronger financial positions than their smaller peers may offer a more resilient dividend.

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Firms with modest dividend payout ratios, meanwhile, may be less likely to cut shareholder payouts during periods of economic difficulty. Even a significant decline in their profits caused by temporarily difficult trading conditions, for example, may mean they are still able to afford their current level of dividend payments.

A rising income

Dividend stocks can also deliver excellent long-term income growth that, in some cases, is significantly positive in real terms. By contrast, cash savings typically fail to provide an inflation-beating income return over the long run. And given the fixed nature of coupon payments, income from bonds gradually becomes worth less in real terms.

In the current economic climate, of course, income investors may naturally question whether the growth appeal of dividend stocks still holds. After all, the UK economy expanded by just 0.3% last quarter, while increasing levels of protectionism mean that the world economy faces an uncertain near-term outlook that could prompt difficult operating conditions across several sectors.

However, the current era of monetary policy easing may not yet have had its full impact on the economy. And with further interest rate cuts in the UK and the US likely over the medium term as inflation moderates, the prospects for dividend growth may be much brighter than many income investors currently anticipate.

Source: Refinitiv as at 9 September 2025. Bond yields are distribution yields of selected Royal London active bond funds (as at 31 July 2025), except global infrastructure bond which is 12-month trailing yield for iShares Global Infras ETF USD Dist as at 5 September. SONIA reflects the average of interest rates that banks pay to borrow sterling overnight from each other (4 September). *Data prior to May is based on 3-month GBP LIBOR. Best accounts by moneyfactscompare.co.uk refer to Annual Equivalent Rate (AER) as at 9 September.

Risk/reward

Undoubtedly, there is an inherent trade-off between dividend growth and dividend reliability. Defensive shares such as those operating in the utility sector, for instance, are unlikely to produce rapid increases in shareholder payouts due to the slow-growing nature of their industry. Likewise, a cyclical company such as a mining firm may offer strong long-term dividend growth potential that comes with the risk of volatile shareholder payouts.

At present, though, larger, financially sound and mature cyclical dividend stocks that have sensible payout ratios could offer income investing appeal as part of a diversified portfolio. Certainly, their income return could prove to be volatile in the short run as tariffs and time lags following interest rate cuts persist. But this risk could be offset by the prospect of an inflation-beating dividend over the long run as the global economic outlook gradually improves.

Dividend growth potential

For example, BHP Group Ltd (LSE:BHP) could prove to be a worthwhile income holding over the long run. The mining company currently yields 4.1%, which is around 80 basis points ahead of the FTSE All-Share index’s income return, with it being well placed to capitalise on several growth opportunities.

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Indeed, the company continues to focus on future-facing commodities such as copper, with its production of the metal increasing by 28% in the past three years. Copper is likely to experience a significant rise in demand as the world seeks to decarbonise, with it used extensively in electric vehicles and renewable energy infrastructure. This could support higher prices and growing profits that allows the firm to raise its dividends.

The company also expects its Jansen project to begin potash production in 2027. Its use as a fertiliser means that demand could be high, given that the world’s population is forecast to rise from eight billion in 2022 to 10.3 billion in the mid-2080s, according to the United Nations. And, as mentioned, with interest rate cuts set to persist over the medium term, the firm’s cyclical status means it could benefit from an improving global economic outlook that drives commodity prices higher.

Sound fundamentals

Of course, BHP’s dividend was cut by 25% on a per share basis in its latest financial year. This was due to a similar rate of decline in earnings versus the prior year, which was largely a result of lower prices for several commodities, with the company’s dividend payout ratio little changed at around 55%. This figure suggests that the firm’s shareholder payouts are relatively affordable at their current level and indicates that dividends could fluctuate in line with changes in profits over the long run. Given the upbeat outlook for the company’s bottom line, this could equate to brisk dividend growth over the coming years.

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Crucially, the company’s recently released full-year results also showed that its balance sheet remains sound. Its net debt-to-equity ratio, for example, is just 24%, while net interest costs were covered 17.5 times by operating profits during its latest financial year. Both figures suggest the company is well placed to overcome potential economic difficulties in the short run. And with the firm having exposure to a wider range of commodities and geographies than several of its mining peers, it may deliver a more stable financial performance vis-à-vis the wider sector.

Share price prospects

Since first being discussed in this column in June 2023, BHP’s share price has fallen by 15%. This compares unfavourably to a 21% rise for the FTSE All-Share index over the same period, which is clearly a disappointing result.

Following its share price decline, the company now trades on a price/earnings (PE) ratio of 13.5. Although income investors may not be too concerned with the potential for capital growth, the firm’s market valuation suggests there is scope for an upward rerating should the economic environment improve over the coming years.

Moreover, BHP’s income investing prospects appear to be upbeat. Undoubtedly, it is a cyclical firm that is highly unlikely to provide a stable dividend, with inherent fluctuations in commodity prices having a direct impact on its bottom line and, by default, its shareholder payouts. But with a solid financial position, a relatively attractive yield and a modest dividend payout ratio, the stock could provide a worthwhile income as it benefits from net zero, demographic changes and the impact of interest rate cuts on the economy over the long run.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.