High-yield stocks have their own risks

High-yield stocks; Churchill China

The markets may be in turmoil, but it would be wrong to suppose that you can't make money on shares. Indeed, many of the Square Mile's fund managers are starting to fill their investment portfolios with companies that offer a real income - in the form of high dividends.

The markets may be in turmoil, but it would be wrong to suppose that you can't make money on shares. Indeed, many of the Square Mile's fund managers are starting to fill their investment portfolios with companies that offer a real income - in the form of high dividends.

Stocks that offer a high "yield" - the company's historic annual dividend payout as a percentage of its share price - can sometimes make your money work harder than high-interest savings accounts. But investors need to exercise caution. A high yield often indicates expectations that the dividend will be cut. Or it implies that the company is troubled, or in mature markets, and that the shares offer negligible upside.

Indeed, the market's highest-yielding stock, Low & Bonar, the building materials group, is expected to pay a dividend of 6p this year, compared to 15.9p in 1999, a dividend that implied a yield of 14.2 per cent. The top 10 high yielders include other similarly troubled companies where future cashflows are hard to predict, such as Somerfield and RJB Mining.

Investors after a reasonably safe income from a stock are probably best off restricting their choice to established firms in the FTSE 100. But even here, investors need to be selective. Among the top 10 stocks with high yields, one - ICI - has said it is likely to halve its dividend in 2002, while another, International Power, has cut its dividend altogether following its demerger from National Power.

Dividends from other blue-chips - notably companies in the utilities and tobacco sectors - appear more secure. As might be expected, the regulated utility stocks present plenty of opportunities for those after income. United Utilities, the FTSE's highest yielder at 7.2 per cent, did not follow the likes of Pennon and Hyder in cutting its dividend following the water regulator's industry review last year.

While that suggests the dividend is safe, such a high yield implies that many investors are sceptical that the dividend, which is covered only about 1.2 times by its earnings, will continue to rise. United has a tough investment programme, and some analysts reckon its dividend could become vulnerable come 2005. Still, the likely flotation of its telecoms arm could generate plenty of cash, and the shares, down 22p at 611p, look attractive.

Perhaps the safest bet is Scottish & Southern Energy. It has pledged dividend growth for the next six years, including a target of 4 per cent growth for the next three. The group, whose shares closed 5p higher at 600p and yield 4.7 per cent, is perceived to have enjoyed a lenient review at the hands of the regulators.

The weakness of Scottish Power's shares has seen it offer a yield of 4.53 per cent. But the market's concerns that the group is exposed to high US electricity prices seem overdone. The shares, up 4p at 478p, offer a secure dividend.

Unlike IPower, Innogy, the UK business that was the other part of National Power, continues to pay dividends. But some analysts are concerned about Innogy's plans to build an overseas business in energy management, which might absorb funds otherwise destined for dividends. While the dividend looks safe for a couple of years, its long-term prospects are harder to assess. Similarly, the growth of Powergen's dividend beyond 2003 will depend on recent investment in the US starting to provide cash.

High-yielding Royal & SunAlliance, the insurer, returned cash to shareholders in a special dividend in 1999, and may as a result find it harder to grow the dividend if its business performs less than strongly over the next two years. Alliance & Leicester, another high-yielding financial stock, is facing stiff competition in the mortgage market, and its shares are not without risk. Investors should be similarly wary of other well-known high-yield stocks, such as Boots, Marks & Spencer and British Airways, whose businesses continue to beset by fierce challenges.

Churchill China Churchill China, the crockery tiddler, issued the welcome kind of profits warning yesterday, saying this year's annual results would be well ahead of City expectations.

Having seen its share price shattered following a slump in the ceramics market two years ago, Churchill has been doing an impressive job of picking up the pieces. Yesterday's cheery trading update showed sales in the crucial fourth quarter of 2000, and particularly in December, piling up.

The quarter had a slow start, Churchill said, as its dining-out division, which supplies catering companies with tableware, was hit by the petrol crisis and poor weather. But a last-minute surge in December meant the china maker was busy delivering plates, cups and saucers to crowded restaurants right up to Christmas.

Meanwhile, the Stoke-on-Trent-based group is making good progress in its plans to establish a "dining in" business. Having taken the painful decision to close one factory - Clarence Works, the mug maker - and cut output at another by 50 per cent, the company has started sourcing some of its products from overseas. It hopes to become the supplier of choice to household names, such as Woolworths, Argos and Debenhams, by providing a one-stop shop offering everything from bone-china dinner sets to hand-printed cups.

Analysts upgraded their full-year forecasts from £1.75m to £2.25m yesterday, giving 15.4p of earnings per share. The revised estimates put Churchill's shares, up 25.5p, or 17 per cent, to 176.5p on a forward multiple of just 11. Unlike so many quoted companies, Churchill has clearly learnt how to underpromise and overdeliver, and the shares still look cheap.