Top 10 FTSE 100 income stocks yield an average of 7.1%

There are plenty of income funds offering yields of 4%, but the recent stockmarket decline means these 10 blue-chips could offer potentially significant dividends over the next year or so. Lee Wild reports.

The hunt for yield has been a key theme for investors since global central banks slashed interest rates to record lows during the financial crisis. Savers seeking income have been forced to look elsewhere, and dividend-paying equities have been a favourite destination. 

But after a nine-year bull run, stockmarkets have risen sharply and some favourite income plays are no longer cheap. The FTSE 100 currently yields 4.3% and many income funds regard this a decent return. 

However, the recent sell-off has inflated some yields - an inverse relationship means that when share prices fall, dividend yields rise, enhancing potential returns. 

A yield of more than 7% is certainly eye-catching, but it should raise eyebrows, too. A number of the companies that make this FTSE 100 high-yield list have struggled in 2018 for different reasons. Some of the declines are probably overdone, but others might imply structural problems.

A struggling company may also be feeling pressure on both profits and cash flow, which may impact its ability to make enough money to pay the dividend. 

This list of the FTSE 100's highest dividend yields weeds out companies at risk of cutting the dividend or scrapping it altogether. All the dividends are covered at least 1.5 times by earnings - dividend cover of less than 1 means the company is using borrowed money to pay shareholders a dividend. 

It also excludes stocks ranked anything other than a consensus 'buy' among analysts.

The 10 most-generous blue-chip stocks 

It's unsurprising to see two of the UK's richest housebuilders returning some of that spare cash to shareholders by way of special dividends. The domestic housing market has run out of steam and housebuilders are vulnerable when the economic cycle turns. That said, there is currently plenty of demand and the shares are cheap.

Insurers are an historically reliable source of dividend income, but whiplash reform and changes to calculations for accident compensation threaten to punch a hole in earnings. BT has struggled for a few years now, and the shares are currently underpinned by break-up hopes and a big dividend. A new CEO will have a job on his hands, but therein lies an opportunity to clear the decks and rethink strategy. 

It would be unusual not to see tobacco stocks represented. British American Tobacco is not every investors' cup of tea, but it rewards shareholders well. Buying Reynolds American replaces a decline in volume across developed markets with sales of e-cigarettes, plus higher volumes in Asia and the Far East. 

The threat of even slower growth in the event of a 'no deal' Brexit, plus prospect of lower demand for loans as interest rates rise, has put banks under pressure, but bulls hope margins should improve and that Lloyds makes enough now to sustain a generous payout.

It's unlikely easyJet would have featured here a couple of months ago, but the shares are down by a third since June as investors fret about rising fuel costs and the usual summer strikes by French and Italian air traffic controllers. However, it has since upgraded full-year profit guidance, promised to pay half its profits as dividends, and trades on single-digit valuation multiples. 

When chasing income, investors must bear in mind that high yields are a reward for shareholders who take on extra risk by owning the stock. The recent sell-off has driven equity yields higher, but capital is clearly at risk in these volatile markets, and none of these blue-chip stocks is immune from an economic downturn. 

That said, while a sharp drop in profits will erode dividend cover, most of these 10 established names have a track record of paying generous but affordable dividends, and will go to great lengths to protect the payout. 

*Minimum dividend cover of 1.5, includes only consensus 'buy' stocks

Source: SharePad, 16 October.