The Market's Top Sectors for Income

LONDON -- One in four companies in the FTSE 100 yields more than 4%, which is well in excess of anything available in a savings account.

About half of those high-yielders are in just three sectors: insurance, utilities, and supermarkets. It pays to diversify your holdings, so if you're building a high-yield portfolio, it's worth making sure that you're not overexposed to these sectors. But it's worth looking at each of these sectors, and I've chosen my favorite share from each.

1. Accident-prone insurers
Altogether there are five life and general-insurance companies paying more than 4%. Insurers pay out a good proportion of their earnings as dividends, so it's important to check the dividend cover when investing in this sector.

Those high payouts owe partly to the maturity of the industry, which means there's not much for companies to invest in, and partly to the share prices' tendency to track embedded value -- essentially, net assets.

General insurance is cyclical, so share prices can be volatile, and not all companies in the sector have an unblemished record of maintaining their dividend.

My pick in this sector is recovery candidate Aviva (LSE: AV  ) (NYSE: AV  ) . It's yielding a fat 7.3%, which is almost too good to be true. There's a risk of the payout being cut when it reports results next month, but on balance I think the dividend will be maintained. New management has been selling off underperforming businesses, slashing costs, and strengthening the capital base.

These asset sales should be enough to fend off the risk to the dividend, and as the company's performance improves, its yield will come back into kilter through the share price rising.

2. Dependable utilities
Utilities are equally well-represented by five companies in the high-yield club, but in this classic defensive sector, their share-price performance is more dependable. The prices that electricity, gas, and water suppliers can charge are fixed by the industry regulator at a level that is supposed to earn them a reasonable rate of return. The scope for utilities to increase profits depends on their squeezing out additional efficiencies or having some unregulated business.

It makes for a stable income flow, periodically punctuated by the uncertainty of where a settlement will be reached in the next regulatory negotiation round. That means at different times, different industries are more or less attractive -- but overall it's in the government's interest that the utilities are sound.

My favorite utility is British Gas owner Centrica (LSE: CNA  ) . Its regulated downstream business is a solid cash-producer, but the company has diversified upstream into being a significant gas-producer with a major stake in the North Sea. The government's newfound enthusiasm for gas in the U.K. energy mix -- dubbed a new "dash for gas" -- will be a boost for Centrica's gas-fired generating business, as well as its upstream production.

3. Ubiquitous supermarkets
They're out of town and on the high street, and you can't get away from them on the stock market, either. All three listed supermarkets -- Tesco (LSE: TSCO  ) , Sainsbury, and Morrison -- yield more than 4%.

That hasn't always been the case. Yields for the supermarkets have been trending upward over the past few years, in tandem with price-to-earnings ratios drifting downward. It's a sign that the sector is increasingly out of favor with investors. Lately, the three listed supermarkets have been squeezed by competition from discounters Aldi and Lidl, as well as upmarket Waitrose.

My money is on market-leader Tesco, whose fight to win back U.K. market share is starting to pay off. A new management structure sees CEO Philip Clarke step back from management of the U.K. stores to focus on sorting out Tesco's U.S. disaster. But he's still in the saddle: The company seems to have survived the "Dobbingate" horsemeat scandal without dent to its reputation or sales.

Picking income stocks
Building a high-yield portfolio is not just a matter of finding which companies pay the biggest dividend. It's a question of which can keep increasing the dividend -- at least in line with inflation -- which means looking at things like the company's prospects, dividend cover, profitability, cash flow, and debt.

There's another great income stock in one of these sectors that The Motley Fool's top analyst has picked as his "Top Income Share for 2013." It's yielding more than 5% and has been steadily increasing the payout. It's in my portfolio, and I expect to hold it for a long time. You can find out which share it is in this exclusive in-depth report. You can download it to your inbox now just by clicking here.


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