Investing for income needn’t be about investing only in the highest dividend yields. A dividend that is too high is liable to be cut in the future, which is against the idea of income investing. It’s better to look for UK shares with dividend yields that are above average, but not so high that they are a warning that other investors think a share is worth avoiding.
These two UK shares, with dividend yields above 4%, offer an attractive combination of dividend income, without an outsized risk of capital loss. Of course, there share prices could go down as well as up. They seem though like a safer investment than many other higher yielding shares.
A consistently high dividend yield
First up is the insurer and asset manager, Legal & General. The FTSE 100 group has for many years been a high dividend payer, making it ideal for income investors. It currently has a dividend yield of over 6%. That’s despite the shares having done well since last autumn.
If the UK economy does continue to recover, as many have predicted, then Legal & General should be a beneficiary. As an investor and asset manager, a stronger economy should be good for the share price.
Recent results have shown full year operating profits fell 3% to £2.2bn, or 4.2% to £2.0bn once the effect of one-off mortality releases is removed. In a tricky year this is not too bad. The result reflects disruption in Legal General Capital and increased claims in Legal & General Insurance.
Coming back to the dividend, because of the already high yield it shouldn’t be expected that dividend growth will be high. This year the dividend has been kept flat. In coming years, Legal & General expects to grow the dividend annually at low- to mid-single digits.
Is the dividend safe despite the high yield on offer? It seems like it is. Management has shown, especially be keeping the dividend through 2020 when other insurers deferred or cancelled their dividends, that they are committed to providing payouts to shareholders.
Dividend cover in 2020 was 1.26. It has been in decline for the last four years, which is a bit of a concern. But the dividend doesn’t seem in immediate danger of a cut. It would be better though if the dividend cover could return to above at least 1.5x earnings.
A pandemic winner
Spreadbetting group, CMC Markets, is my second higher yielding share pick. It’s a share that’s been covered before and arguably compares well against its main listed competitor, IG Group. CMC Markets operates in 12 countries and around 57,000 clients. Its CFD and spread betting business covers Europe, UK, Ireland, Australia, New Zealand, Singapore and Canada.
The shares currently support a dividend yield of 4.5%. The dividend at the FTSE 250 company has, like it’s dividend growth, tended to fluctuate, but it’s never been consistently below earnings and therefore not in danger of being cut.
CMC Markets has been a winner from the pandemic. Its share price in 2020 rose by 160%. 2021 started well, but now the shares are well off their highs.
On the back of its strong financial performance through the pandemic, CMC Markets was able to raise its dividend by 640%. That kind of rise clearly can’t be sustained. The quality of the business does mean though that earnings could support a steadily growing dividend.
All in all, the CMC Markets share price could reward investors with a growing dividend, as well as a yield is excess of 4%. It also seems to be a well run company, with its founder, Peter Cruddas, still a major shareholder. Given the operational progress in recent years and the attraction of new high value clients, the company may well continue to perform well for years to come, supporting the dividend – and likely the share price as well.
The risks with Legal & General and CMC Markets
As with all investments, both these shares has risks. For Legal & General one of the biggest risks is around bond prices and also how it calculates future annuity provisions. It’s also highly intertwined with the UK economy so any macro issues are likely to hit its share price hard.
The downside of a continually high dividend yield is that it means Legal & General’s management isn’t reinvesting as much back into the business to support future growth. Perhaps the nature of the business means that is less necessary? It already has a strong brand, established markets and so forth, but it is a theoretical risk and probably worth keeping an eye on, if invested in the group.
Lastly, on Legal & General, it is quite focused on the UK, which reduces geographical diversification; but on the flipside makes it a leaner and easier to manage business.
When it comes to CMC Markets, the risk is of further regulation. CMC itself notes in its annual report that the Australian regulator, ASIC, set out proposals for regulatory intervention in the market for binary options and CFDs in August 2019. It has taken steps to mitigate these risks, for example by targeting sophisticated investors, but nonetheless the threat of regulation has hit the shares in the past. If the threat reoccurs the reaction from investors would likely be similar – to sell the shares.
CMC Markets also has tough comparisons against 2020, when it performed so well. Can it top that? Also, it’s potentially quite a volatile business compared to the more ‘Steady Eddie’ nature of Legal & General. All financial stocks are cyclical, but CMC Markets probably more so than most given clients will usually spreadbet more when markets are violently moving up and down.
Overall, these companies with their decent dividend yields seem to offer investors a combination of income and the possibility of capital growth as well. That seems like a decent enough reason to consider them.
Please note I own shares in Legal & General.
This article is not intended as a recommendation and the share prices, like all others, can go up and down.
If you like this article then check out this one on ESG investing.