The stocks to consider for the best returns

The high-wire acts

These are the stocks with the biggest forecast yields — close to 7 per cent — but where the higher prospective payouts come with a generally greater risk of dividend cuts.

Laith Khalaf, of Hargreaves Lansdown, the wealth manager, highlights BHP Billiton, currently yielding 6.7 per cent, as a classic tightrope walker. He says: “It is another casualty of the commodity sell-off. It has a policy of at least maintaining dividends but might face pressure if commodity prices remain depressed.”

He thinks Royal Dutch Shell, also yielding 6.7 per cent, is a better bet. “The company has announced it will at least maintain its dividend until the end of next year, however, it remains at the mercy of the oil price, which is largely outside its control.”

Garry White, of Charles Stanley, the stockbroker, picks out Admiral, the car insurer, as an example of a stock which may struggle to maintain its yield of 6.1 per cent. He says: “There is some uncertainty about the sustainability of earnings at the company. The better-than-expected recent figures were the result of Admiral releasing some of the reserves that had been set aside to cover future claims. Many think this is unsustainable and car insurance premiums remain weak.”

Bargain buys

Some companies have been sold down indiscriminately in the recent market correction and are now offering healthy yields coupled with the prospect of some capital growth on top as their share prices rise.

Khalaf thinks two stocks which fall into this category are Standard Life and Pearson, both on a prospective yield of 4.5 per cent.

“Standard Life’s dividend has risen every year since the company listed in 2006,” Khalaf says. “The shares are now about 15 per cent cheaper than they were six months ago, without any discernible reason for this apart from the market’s increased risk aversion.

“Pearson has increased its dividend by more than inflation for the past 23 years. The recent sale of the FT and Economist has left the company with a £1 billion war chest to invest in transitioning from print to digital publishing.”

Steady Eddies

Typically these stocks are solid businesses that offer little growth but steady dividends.

Khalaf and White both like National Grid, which yields 4.8 per cent. White says: “This gas and electricity network operator is a dividend stalwart, because earnings are relatively predictable due to multi-year regulatory agreements in the US and UK. Management remains committed to increasing the dividend at least in line with inflation.”

Khalaf’s other choice is United Utilities, which carries a yield of 4 per cent. He points out that the company aims to grow the dividend at least in line with inflation until 2020, which, he argues, is attractive in the current low interest rate environment.

Dividend growers

This category consists of stocks that already pay a reasonable dividend, but have the potential to grow it more in the future.

Khalaf likes Lloyds Bank, with a forecast yield of 4.6 per cent and Next, on 4.2 per cent . He says Lloyds, which will offer the public a £2 billion tranche of shares at a 5 per cent discount next year, is returning to its dividend-paying ways after six years in the wilderness. He adds: “The bank has rebuilt its balance sheet and should be able to return cash to shareholders, especially once PPI claims start to fall away.”

Khalaf likes Next because it has a strong record of returning surplus cash to shareholders through special dividends and share buybacks. The retailer should also benefit from consumers having more money in their pockets.

White goes for Barratt Developments, the housebuilder. He says: “Builders have changed their business model to operate with minimal debt, build for margin, not volume, and distribute excess cash. The prospective yield of 4.8 per cent compares with last year’s yield of 2.5 per cent.” He adds that Barratt is unlikely to be short of work because there will be a shortage of housing in the UK for many years.

He also, like Khalaf, sees potential in Lloyds Bank, which he thinks has plenty of scope to increase its payout. The big cloud on the horizon, he says, is the risk of further misconduct fines and compensation claims.

Up and coming

These are stocks which may not yield 4 per cent yet, but whose underlying dividend growth looks set to push them over that level very soon.

Khalaf picks out BT, the telecoms giant, and Capita, the outsourcing company. He says BT, on a yield of 3.4 per cent, expects to grow its dividends by 10 to 15 per cent a year and its streamlining of costs and entry into the world of pay TV via BT Sports reinforces the chances of higher dividends.

He likes Capita, yielding 2.7 per cent, because it has produced double-digit growth in dividends for almost 20 years and its revenues should continue to be sustained by the continuing drive to cut costs which is taking place in both the public and private sector.

Stocks to avoid

White says that Anglo-American, yielding a forecast of 6.2 per cent, is one of the weakest shares in the FTSE 100 because of the commodities rout, and it surprised many by maintaining its interim dividend. He adds: “The chief executive is cutting costs and reorganising the company’s operations, however it continues to be weighed down by concerns about its high debt level and its large exposure to South Africa and a slowing economy in China.”

Khalaf adds: “Picking stocks purely for their yield is a recipe for disaster. Dividends are a very important source of return for investors, but they need to be considered in the context of the other factors affecting a company’s performance. In particular a very high yield implies some scepticism about whether the forecast dividends will be delivered.”

Choosing an income fund

If you prefer the greater spread of risk that you achieve through buying a fund, rather than individual stocks, Sam Lees, of Fundexpert, the investment website, suggests M&G Dividend and Jupiter Income Trust.

He says: “We like funds that investors can rely on consistently to grow their payout and these funds meet that requirement. The Jupiter fund offers a solid yield of 3.9 per cent while the M&G fund offers a slightly higher yield, at 4.6 per cent. Both have a record of payout growth stretching back seven and eight years respectively.

“While both have a large exposure to financials, M&G has higher allocations to industrials and basic materials, while Jupiter has more in telecoms.”

For income-producing investment trusts, Charles Cade, of Numis Securities, the stockbroker, suggests City of London and Edinburgh. He says: “City of London is yielding 4 per cent and has a strong track record, having returned 157 per cent over the past 10 years, compared with just 84 per cent for the FTSE all share index. The manager, Job Curtis, is very experienced, having been at the helm since 1991 and the trust has a record of 49 successive dividend increases. The trust’s charges, at 0.43 per cent, are among the lowest in its sector .”

“The Edinburgh trust is run by Neil Woodford’s successor Mark Barnett, who is an outstanding manager in his own right. The trust has returned 204 per cent over 10 years and has a comparatively low management charge of 0.5 per cent.”