In our recent blog articles on the subject of our buying process, we’ve explained the need to identify your investment strategy, find shares that fit your strategy and the need to do your own research rather than blindly following tips in share magazines or newsletters.

It is now time for step 4 of our 10-step buying process, that is, choosing which share to buy.

If this is your first share then there’s no need to consider the rest of your portfolio.  We will assume that is the case here as portfolio management is a whole new subject!

Buying high yield shares

We know from my article on how to identify high yield shares that we need to use the key ratios known as dividend yield and dividend cover as a filter.

We do this by sorting on the Dividend Yield, highest first, down to the lowest.

As of the close of stock market business today (19th August, 2011), the top five yielding shares in the UK FTSE 100 are:

Rank Company Yield Cover
1st Aviva 9.5% 2.6x
2nd RSA Insurance Group 9.3% 1.1x
3rd Man Group 8.8% 1.3x
4th Resolution Ltd 8.7% 4.5x
5th BAE Systems 8.3% 2.3x

UK FTSE Top 5 Dividend Yielding Shares

The first thing to notice about this list is the phenomenal dividend yield that is on offer after the falling stock market events this week!

Not long ago, these same shares were yielding 6%-7%, now they are yielding 8%-9%.

Compare that with the rate of interest you could earn on a UK deposit account i.e.  2% – 3%?  In other words, by investing in these shares, you can earn 3 to 4 times more return from your cash.  So which one might you invest in first?

Going back to the list then, the next thing to notice is that 3 of the shares are insurance companies (1, 2 and 4), one is a hedge fund manager (3) and one is a Defence company (5).  All three have suffered falling share prices recently and that is why they are yielding more than usual.

You need to decide whether they will fall further or rise over the timescale of your investment.  That’s because a 10% fall in share price in the next year will wipe out the gains you will make from the dividends (the yield is per annum).  Whilst this is not necessarily going to happen, it’s entirely possible and some would say likely in the short-term, especially given current markets.

Then again, this could be their low point and rise from here.  If you are investing for the long-term (and you’ll need to earn several instances of the dividends) then it is reasonable to expect the shares to rise from here (although again, nothing is certain).

So assuming you are investing for the long-term and still want to buy one of them – which one?

Which High Yield Share To Buy Now?

Looking again at the list, Man Group and RSA Insurance Group have relatively low dividend cover.

The cover of just above one means that most of their profits are being paid out in dividends.  Whilst this might sound good, it means that if their profits were to fall, then the dividend would more than likely reduce to conserve cash which would, in turn, cut their dividend yield.

Resolution has the highest dividend cover at 4.5 times profits suggesting that its yield is the safest and even offers scope for the dividend to rise, thus raising the yield above 8.7% assuming the profits are stable or increasing in future.

Aviva does not offer a dividend cover as high as Resolution, but is still very healthy at 2.6 times profits.  It’s dividend yield is the highest at 9.5% which is phenomenal!  Normally, companies with yields as high as this are in deep trouble and to be avoided but Aviva has only just published its results which were very encouraging.  Arguably, this could be a better investment than Resolution?

If you don’t want an insurance company (maybe you are concerned that it is a financial services business and that it’s vulnerable with markets as they are), then you might consider BAE Systems which is a Defence manufacturing and services business.

It too has a healthy dividend cover of 2.3 times profits and a fantastic yield of 8.3%, albeit not as high as the others.  It’s future prospects depend on Defence spending by its customers which are Governments in the main, hence the reason for its price falls in the short-term because UK and US Governments, two of its key customers are cutting their Defence spending.

However, we live in an uncertain world.  UK and US Governments (as well as others) are actively involved in Defence activities across the world and you may view the recent price falls as too harsh.

Further Research

Whichever share you think is your favourite, it is important that you do further research on the company before investing your money.  This will also help you narrow down your preferences further and confirm your choice.

I’ve mentioned a few things to consider in this article but there are other things to consider such as the level of debt being carried by the company, whether there have been any recent profit warnings, etc.

Ultimately, it is your personal choice whether to invest in shares and in which companies, not mine!

It is also vitally important that you make your own decisions so that you can learn how to be a better investor.

If you’ve found this article useful, please leave me a comment with your thoughts – I’d love to hear from you.

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Best regards,

Adrian

Disclosure:  At the time of writing this article, the author holds shares in Aviva, RSA Insurance, Resolution and BAE Systems.