When considering dividend yields, UK investors tend to be cautious around the 7% level. This is often considered an area where payment stability is questionable. If a company allocates too much cash to dividends, it can lead to operational problems and weaker performance.

At this point, dividends are usually cut, causing shareholder dissatisfaction. This, in turn, discourages novel investments and leads to a downward spiral.

There are sometimes exceptions to the rule, but it is considered a good estimate to rely on.

With this in mind, I prefer to aim for an average yield of around 6% to stay on the protected side. The yield on such a portfolio can sometimes exceed 7%, but generally remains stable.

Look beyond the yield

Even a yield below 7% guarantees nothing, as the company may still have difficulty covering payments. To really assess payment stability, it helps to look at debt and free cash flow.

Companies spend free funds in different ways. They can be saved, used to reduce debt, spent on share buybacks or paid as dividends.

Debt is not a problem as long as interest is paid. If not, dividends may face a hurdle. However, with cash flow and well-covered debt, there is no reason to cut dividends.

Don’t forget to diversify

Companies operating in similar industries usually have similar financial results. So, when looking for sustainable returns, an investor can choose four insurance companies. Sure, they can all be reliable dividend payers, but the portfolio would be too exposed to one sector.

It would be better to choose the most reliable, high-yielding dividend stocks from four different industries. Diversification is about balance.

Two examples

To consider National Network AND ITV (LSE: ITV). They operate in a variety of sectors, maintaining consistently high rates of return and dividend coverage ratios above two.

As the UK’s main supplier of gas and electricity, National Grid enjoys consistent demand and stable revenues. Its business is well regulated, making it quite stable, and annual dividends have been growing consistently for over 20 years.

However, it faces pressure from skyrocketing energy prices and costly upgrades to meet decarbonization targets. This has led to growing debt, a problem made worse by rising interest rates. In the face of sinking cash flow, it recently cut its dividend by 15%.

On the other hand, ITV has enjoyed growing equity capital while recently reducing its debt. It lacks a solid National Grid-level payment history, but enjoys steady cash flow. This reduces the chance of dividend cuts, making a 7% yield attractive.

However, the competition is fierce for players like Netflix, Disney, AND Amazon enters the digital streaming market. While ITV continues to generate decent value from its studio, profits are at risk as a result of streaming losses.

This partly contributed to a slight decline in revenues in 2023, from £3.73 billion to £3.62 billion. However, the company’s first half 2024 results show some recovery, with revenues up 2.4% and profit margins rising sharply to 17% from 2.6% a year earlier.

These examples show how different dividend stocks can be, and yet both remain popular options and are worth considering as part of your income portfolio.