Opportunities for High Dividend Yields in the U.K.

Published Mon, 27 Aug 2012 09:00 CET by TopYields.nl

Investors in pursuit of high dividend yields have plenty of reasons to focus on the U.K. equity market. Currently, on average, U.K. stocks are paying higher dividend yields than U.S. stocks. For example, the FTSE All-Share index is paying a dividend yield of 3.62%, compared to a yield of just 1.5%, on average, for the U.S. broad Russell 2000 index. Even large-cap U.S. stocks in the S&P 500 index are yielding a mere 2.1% on average. On the other hand, U.K. stocks are yielding much more than government bonds. For instance, the U.K. broad equity market's yield is 140% higher than the yield on the U.K. 10-year gilt. Obviously, all this should put U.K. dividend payers on the radar of the U.K. and global income investors.

Still, income investors in the U.K. market have an opportunity to obtain even higher yields than the noted lucrative averages. There are several exchange-traded products and select high-quality stocks that offer distribution/dividend yields that can hardly be matched by investments of a comparable risk-return profile.

For example, in general, a good place to look for safe high-yield U.K.-based dividend stocks is the S&P U.K. High Yield Dividend Aristocrats Index, which consists of 30 highest-yielding U.K. stocks within the S&P Europe Broad Market Index. The S&P U.K. High Yield Dividend Aristocrats Index balances high dividend yield with dividend sustainability and growth. It includes only those companies that have dividends covered by earnings, with a maximum yield of no more than 10%, and the history of dividend hikes for at least 10 consecutive years. Investors can purchase the entire index in a form of an exchange-traded fund (ETF), SPDR S&P U.K. Dividend Aristocrats ETF. This ETF has an expense ratio of 0.3% per annum and boasts a distribution yield of 4.42%, with distributions made twice yearly.

Another ETF that tracks attractive dividend-paying stocks in the U.K. is the iShares FTSE U.K. Dividend Plus ETF (LSE: IUKD). This ETF tracks performance of the FTSE U.K. Dividend+ Index, which consists of the 50 highest-yielding U.K. stocks within the universe of the FTSE 350 Index (measuring the performance of the 350 largest U.K.-listed stocks by market capitalization). Almost a third of the ETF's allocation is in the financial sector, followed by consumer services and industrials. The ETF has an expense ratio of 0.4% per annum and a distribution yield of 5.21%. The fund makes distributions quarterly. However, please note that while this ETF has outperformed the broader equity market this year, since inception in 2005 it has markedly underperformed the broader market.

While ETF investing allows for diversification, investors can also focus on investing in individual dividend-paying stocks, especially those of high quality, with sustainable earnings power and dividend growth. For example, investors can choose from among the constituents of the aforementioned indices. Some of the recommended investments options are listed in the table below:

U.K. Dividend Yield Table
Moreover, dividend investors can follow the advice of the analysts at investment bank Morgan Stanley, who recently made a special screen to identify the best U.K. dividend stocks for the next two years. Looking for stocks with a high-return potential, investment safety, and a prospect of dividend growth, Morgan Stanley's analysts selected the best U.K. dividend stocks based on a high yield and dividend growth over the next two years; payout ratio below 75%; market cap above £3 billion, strong balance sheets with a debt-to-equity ratio below 30%; and free cash flow yield above 5%. Their screen identified the following stocks as the best dividend investment opportunities:

2013 Dividend Yield (estimated) Table
All of the aforementioned investments pay dividend yields in excess of the current rate of inflation, the average dividend yield on the broad stock market, and the benchmark government bonds. Moreover, all U.K. dividends are exempted from the U.K. withholding taxes. Therefore, the aforementioned dividend ETFs and stocks should be considered as attractive investments by prudent equity income investors.

Stock name Dividend Yield
Royal Dutch Shell A 7.84
Royal Dutch Shell B 7.79
Carillion 7.53
Pearson 7.33
Royal Dutch Shell-a 6.67
Pearson 6.49
Royal Dutch Shell-b 6.33
Vodafone Group 5.98
Vodafone Group 5.94
Centrica 5.54
Astrazeneca 5.30
Astrazeneca 4.72
Icap 4.70
Tate & Lyle 4.20
Bae Systems 3.51
Relx 2.70
Relx 2.36
Sage Group 2.26
Reckitt Benckiser Group 2.23
Balfour Beatty 0.32
Bae Systems 0.00
Tesco 0.00
Tesco 0.00

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