While this year’s stock market weakness is bad from a capital returns perspective, it does have some benefits from a dividend perspective. A reduced share price will serve to push up dividend yields, assuming there is no change to dividend forecasts as a result of earnings pressures.

Therefore now could be a good time to look for some high quality dividend-paying stocks, avoiding those that trade on high valuations and only picking companies which generate sufficient cash flow to fund the dividend.

WHAT’S ON OFFER?

Sixty two companies in the FTSE 350 index now have a prospective dividend yield greater than 5%, according to SharePad data. And 109 stocks have at least 4% prospective yield.

There are a few points to consider before you start researching potential income investments.

1.  Are the shares expensive, even after the global market sell-off? 

It is important to never overpay for investments. You must look closely at different valuation metrics and make a judgment as to whether the current rating is justified based on a company’s expected earnings growth, market position and competitive advantage.

2.  Is the dividend comfortably covered by free cash flow?

Free cash flow is cash generated from operations, less the amount of money a company needs to reinvest back in its business to keep it competitive.

The money left over after capital expenditure can be used to develop new products, make acquisitions, reduce debt and pay dividends.

HOW TO FIND FREE CASH FLOW DATA

For this article we used SharePad which is one of several financial data websites that let you filter the markets. We looked at forecast free cash flow dividend cover, stipulating a minimum cover ratio of 1.5-times. That means a company is expected to generate at least 1.5 times as much free cash flow as its forecast dividend payment.

We also searched for stocks yielding 4% or more; are trading in a forward price-to-earnings (PE) range of 7 to 17; and have a minimum 5% forecast pre-tax profit growth.

AJ Bell’s latest Dividend Dashboard report says the 10 highest forecast dividend yields in the FTSE 100 are starting to look ‘questionably high’. Many of these stocks have seen share price declines for some time because of company or industry-specific issues and not simply dragged down as a result of February’s broad market sell-off.

As such, we’ve applied a filter to say shares in our search results mustn’t have had a negative share price performance in the six months before February’s market decline. The end result is a list of nine stocks as seen in the accompanying table (and none feature in the FTSE 100’s top 10 highest forecast yielders).

This won’t be a perfect list as forecasts aren’t always correct and shares are still vulnerable to market volatility. However, it provides a good starting point for you to undertake further research. (DC)

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