Should I Chase Yields to Beat Soaring Inflation?

Inflation of nearly 10% is making investors look closely at yields and returns. Buying high-yield shares may be a natural reaction, but could be a mistake

James Gard 30 June, 2022 | 7:48AM
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This week we’ve updated our monthly list of the highest yielding FTSE 100 companies.

Tobacco company Imperial Brands (IMB) remains at the top with a yield of 7.59%, while drinks company Diageo (DGE) is number 24 with a yield of just over 2%.

This month we also examined whether these yields are "good" enough in a period when inflation is at 9% and rising, and investors can get a risk-free return of nearly 2.5% from UK government bonds. We’ve scoured the FTSE 100 to see if any stocks manage to beat the current inflation rate and, more broadly, looked at whether yield chasing is a good idea.

Our monthly screen excludes stocks without a narrow or wide economic moat. Moats matter for a variety for a variety of reasons – research suggests that longer-term performance tends to be better than no-moat companies; they tend to be more resilient in times of market downturns; and they even have a lower ESG risk.

Running the FTSE 100 data again, it’s clear that the best forward yield you can get with a moatworthy stock Imperial.

Yields on The Top Floor

That's all well and good. If you do happen to remove our moat criteria, however, a revised list exposes an extra ceiling of yield that goes all the way up to 12.31%.

That's the case with no-moat housebuilder Persimmon (PSN), which has been a lucrative source of dividends for investors since the end of the financial crisis. There are seven companies with a yield higher than Imperial, and they are miners, housebuilders and financial services companies: Persimmon, Rio Tinto (RIO), Taylor Wimpey (TW.), M&G (MNG), Antofagasta (ANTO), abrdn (ABDN) and insurer Phoenix Group (PHNX). Of these, only the top five beat May’s consumer price index rise of 9%.

A clickbait headline of "These FTSE Shares Beat Inflation" would tell only part of the story of what’s currently going on with dividends and yields.

UK dividends are still firmly in recovery mode after 2020’s crisis, which saw dividends axed, cut and frozen amid the peak of the coronavirus market panic. The hangover from that period is still with us: Centrica (CNA), which has just been promoted to the FTSE 100, is expected to restore its dividend this year, having last paid out in June 2020. The key takeaway is dividends are never guaranteed, and even "safe" payers can let you down.

That was especially true of the 10%+ yielders just before the pandemic struck, so income investors are right to be cautious about double-digit yields.

Further back, companies like Royal Bank of Scotland (now NatWest) were boasting 10% yields and strong capital gains just as the financial crisis (and nationalisation) arrived – putting paid to the idea that investors can have the best of all worlds in one stock. The post-crash landscape saw high growth/no or nominal stocks like Apple and Amazon leave "boring" income stocks in the dust.

Yields and Prices

What is a high yield? Let’s get back to basics. A stock with a share price of 100p and a dividend of 10p yields 10%. If the share price falls and the dividend stays the same, then the yield goes up. So a period of weakness for a company can artificially boost the yield, which is superficially appealing to an investor as a headline figure, but is misleading.

Our notional share could fall to 50p, its payout is still 10p but the yield has doubled to 20%. It hasn’t become more attractive to an investor in the process, as its share price would have to increase 100% to get back to evens for someone who bought at 100p. In this sense, a surging yield could be a warning sign unless it’s accompanied by a dramatic increase in the actual payout. This works both ways, as a surging share price can knock the yield down.

High dividend yields also don’t operate in a vacuum. Investors are dealing with a highly volatile market and defensive and/or value companies are back in favour after a long period in the wilderness. Resilience and downside protection are now prized qualities, but even among dividend stocks these are hard to come by.

Four of the high-yielding companies on our list have posted negative returns in share price terms only this year, although this turns to a positive gain for M&G when income is taken into account. And dividends soften the blow at Persimmon, Taylor Wimpey and Antofagasta, while boosting the returns at Rio. Persimmon shares are undervalued after a chunky fall this year, according to Morningstar, and are trading at a 15% discount to their fair value.

Accepting Volatility

In an ideal world, investors would own shares that grow in value and consistently increase dividends over the long term (that’s a separate issue, covered in our article about stocks that increased their dividends over the last 10 years).

But conditions are far from ideal as we enter the second half of 2022 and investors are being forced to compromise, accepting volatile share prices as long as the payout is increasing. Dividends are increasing this year, but companies are generally being conservative about the extent of the increases. The upcoming reporting season will reveal more about FTSE 100 firms’ intentions. 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

James Gard  is senior editor for Morningstar.co.uk