Why your investments might be promising something too good to be true

Hayley Kirton
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Is too big a payout too good to be true? (Source: Getty)

Investors usually wouldn't turn their nose up at a bumper dividend payout, but research out today has warned many FTSE 100 companies might be promising more than they can deliver.

Nearly half (48) of FTSE 100 firms have planned for dividends which are more than two times their forecast earnings for 2016, which AJ Bell cautions would be the level required to adequately protect a payout should business unexpectedly take a downturn.

According to the research, the average dividend cover across the FTSE 100 is just 1.47 times forecast earnings.

AJ Bell also warned that the ten stocks currently forecast to pay out the highest level of dividend in proportion to their share price in 2016 have forecast earnings-to-dividend cover of just 1.22, and none of them have forecast earnings which are more than two times dividends.

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"Reinvested dividends have accounted for 65 per cent of total returns from the FTSE All Share over the past 30 years," explained Russ Mould, investment director at AJ Bell. "It is therefore tempting to just seek out the stocks that might pay the highest dividends.

"However, investors looking at high yielding stocks must look at dividend cover as well as the headline forecast yield, because some of the juiciest-looking forecast dividend yields could just prove too good to be true.

"Ideally you want a company’s earnings to be twice the size of the dividend payment to give it a cover of two."

Meanwhile, seven firms in the FTSE 100 are being particularly lavish, with dividend cover of less than one times forecast earnings.

Mould added: "Anything below 1.5 times earnings cover starts to question the sustainability of the dividend should anything go wrong and anything below 1 means the company is having to dip into cash reserves or borrow or sell off assets to pay their dividend."

However, all hope is not lost for investors hoping for generous dividends, as AJ Bell also identified 10 firms, including Lloyds, EasyJet and Barratt Developments, which have a forecast dividend yield of over three per cent this year which also have more than two times earnings to cover this.

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