Can a Statistical Test Predict Dividend Cuts?

LONDON -- When is a high yield too high? For income investors, it's a critical question. A beaten-down share often offers a juicy yield -- but the company in question could well be beaten-down for good reasons, and that tasty-looking yield promptly vanishes as the dividend is slashed.

As I wrote the other day, poor dividend cover is one sign that a dividend may be cut. Other financial metrics, such as poor interest cover, trigger similar alarms.

But here's another way of spotting potentially problematic payouts.

Blast from the past
A couple of years ago, I related how, back in June 2007, I had set about looking for suspiciously high yields using a dividend spreadsheet published by longtime Fool reader StepOne -- a much-valued tradition now carried on by Kiloran.

For those of you with a statistical bent, I was looking for yields that were more than one standard deviation greater than the FTSE 100 (INDEX: ^FTSE) average yield.

For those of you not of a statistical bent, "standard deviation" refers to the measure of dispersion in a population or sample. In other words, I was looking for shares with a yield sufficiently far away from the average so as to be suspicious.

At this point, I won't say any more; refer back to the original article for further details. Suffice it to say that the vast majority of the 14 shares identified went on to hit trouble -- cutting the dividend, launching rights issues, going bust, or indeed some combination of all of these. Check the list to see for yourself.

The danger zone
Two years on, I thought I'd repeat the exercise -- but looking for shares displaying danger signs today. Put another way, which shares right now have yields high enough to trigger alarms?

Twelve companies, it turned out, have forecast yields that are at least one standard deviation higher than the FTSE 100's average forecast yield of 3.7%.

Source: Bloomberg.

Cause for concern
Interestingly, I hold four of these shares myself. At least seven are popular picks with most income investors, such as those who you'll find on our popular High Yield Portfolio discussion board.

So should we be worried?

The answer, in short, is both yes and no. A steady-as-you-go utility such as SSE, for instance, can afford a high payout. What's more, SSE prides itself on its payout, boasting that it is one of just six FTSE 100 companies to have delivered a real dividend increase every year since 1999.

Other companies, such as BAE Systems and AstraZeneca, seem to have high yields because worries about their prospects have -- hopefully temporarily -- driven down the share price.

But other companies would seem to have a case to answer. The new chairman at Aviva, for instance, will only go so far as to express the hope that the dividend can be maintained. And as I wrote last week, Standard Life and Admiral join Aviva in suffering from low dividend cover as well.

Woodford holds two
One investor well used to evaluating the prospects of income shares, of course, is Neil Woodford, who looks after two of the country's largest investment funds and runs more money for private investors than any other City manager. Interestingly, two of these shares feature among his largest holdings -- a strong sign that he sees their dividends as sustainable.

Which two companies are they? All is revealed in this free special report from The Motley Fool: "8 Shares Held By Britain's Super Investor." It profiles eight of Woodford's largest holdings and explains the investing logic behind them -- including the two shares in question, of course.

Want to learn more about shares, but not sure where to start? Download our latest guide, "What Every New Investor Needs To Know" -- it's free. The Motley Fool is helping Britain invest. Better.

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