Dividend sustainability

[funduffer]

The 'too high' thread has been interesting and lively, and to me has revived a long-standing problem for me in setting up and managing a HYP - namely, how to judge dividend sustainability when purchasing a share.

This seems to be the unspoken part of the HYP methodology - what metrics to use, how reliable they are, and how easy they are to evaluate.

HYP is aimed at non-professional investors, and I am certainly one of those. I have a superficial understanding of company accounts, and a certain degree of scepticism in believing some of the data they contain. So I need, and I think a lot of HYPers with my sort of background also need, some simple metrics that can be found relatively easily that at least increase the odds of dividend sustainability over the long term.

I can only say what I have been doing over the last 8 years or so since I started my HYP, and maybe others will chip in with some useful pointers.

Yield

The yield at time of purchase is itself an indcator of sustainability, at least in my experience. Eithout wanting to repaet the debate in the 'too high' thread, yield needs to be high enough to justify being in a HYP portfolio, but not so high that it suggests a cut is imminent. 'Chasing the yield' and 'catching a falling knife' are the phrases that come to mind. One can introduce limits like 2 x FTSE 100 yield, or 2 x CTY yield, or Luni's danger zone methodology, but I personally don't like a hard limit, and try and make a case by case decision. This is not easy and I have made several mistakes over 8 years.

At least yields are easy to find. HYPTUSS is invaluable for this.

Dividend Cover

I used to look for HYP shares with a dividend cover (historic and forecast) greater than 2. It became quickly apparent that this would exclude so many shares that the HYP would not be viable. So I have tried to find shares with cover >1.5 (excluding REITS). I realise this is a flaky metric, but it is better than nothing and at least is a crude direct measure of dividend sustainability. The company with the lowest cover I have purchased recently is abrdn at 0.9.....and it has cut it's dividend, but then the pandemic has caused many other companies to cut. And yet, most of these other companies are increasing dividends again, whilst abrdn has not.

Forecast cover is available in HYPTUSS, and historic cover can be found on Sharecast (which I hate as a website, but does hold the information).

Rising dividends over previous 5 years

I am keen on this metric and followed it religiously at the start of my HYP adventure. More recently, the pandemic has undermined it in many cases, so I am now looking at how quickly dividends are being restored before any purchase / top-up decision.

The data is easily available on dividenddata which I find very instructive.

Free Cash flow

Following some posts by monabri a year or two back, I started looking at this metric. Morningstar has the data going back 5 to 10 years but is quite hard to find. As FCF/share can be volatile from year to year, I summed it over a 5 to 10 year period and compared it to dividend per share summed over the same period. If FCF>dividends then this is a good sign.

Unfortunately, I can see little correlation between the good and bad dividend payers and FCF at least in my HYP, so I have pretty much abandoned this.

Shorting

There were threads a few years ago on this, and it is a reasonable and easy metric to check on (see here https://shorttracker.co.uk/ ). Anything over 5% to me is a risk, and anything over 3% is to be wary of.

Anyway, that is what I have used to date.

What do others do? Do you scrutinise the accounts, or use anything else?

I could be an interesting discussion.

FD