The Economist wrote in the aftermath of the 2008 financial crash that the crisis had led to the largest number of dividend cuts and suspensions since the Great Depression of the 1930s.
Income investors were reminded of the fact that dividend payments are far from certain. This type of risk doesn’t go away. People just forget about it for a while. Then, before you know it, one of your 'safe' companies has issued a profit warning and is cutting its dividend.
In the UK, 2018 was a terrific year for dividends but a bad one for share prices. This pushed yields to extraordinary heights. A very high yield is often a sign of trouble ahead, as investors know that company earnings can evaporate when the economy turns down.
One of the quickest ways to kick the tyres on your current dividend generators is to check the dividend cover (earnings per share divided by dividend per share). Dividend cover is the inverse of the dividend payout ratio. Dividend cover of two times or above is strong. Anything below one and a half times - as is the case for J Sainsbury (LON:SBRY) - should be stirring us to investigate in more detail.
Calculating J Sainsbury’s dividend cover ratio
A low level of dividend cover means that a small decline in earnings could consign your dividend payment to the scrap heap. It happens all the time. With that in mind, let’s take a look at J Sainsbury’s (LON:SBRY) dividend cover.
We can get all the information we need to see if J Sainsbury has an adequate level of dividend cover from the group’s stock report. The group’s trailing twelve-month earnings per share is 11.7p and its trailing twelve-month dividend per share is 10.2p.
Divide the former by the latter and we get a trailing twelve-month dividend cover for J Sainsbury of 1.15. This is below the 1.5 times cover limit that marks the point at which we should do some further digging on dividend sustainability and safety.
Systematic investing: the factor is your friend
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One of the most useful benefits of a strong track record of sustainable, rising dividend payments is often a reduction in share price volatility. This area is at the forefront of academic investment research and papers continue to be published on how to tap into what is referred to as the low-volatility anomaly. That's why we have created our own RiskRatings, which categorise stocks according to their volatility and offer you another way to think about your investments
Disclaimer: These articles are provided for information purposes only. The content is not intended to be a personal recommendation. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser. The author has no position in the stocks mentioned, unless otherwise stated.