Could these super-high UK dividend yields be at risk?

My investment style has evolved over decades, but I mostly hunt for cheap shares and chunky dividend yields. But the problem with being a bargain hunter is that giveaways are hard to find.

Still, I keep sifting through the FTSE 100, hunting for undervalued stocks. I particularly enjoy unearthing cheap Footsie shares, as I see the UK market as undervalued in historical and geographical terms. Furthermore, almost all FTSE 100 member companies pay dividends to shareholders.

Dividends can be dicey

After companies pay out dividends, their cash piles are smaller. And repeatedly paying excessively generous dividends can weaken a company’s balance sheet. This might cause solvency problems at some firms, but companies usually respond by slashing future dividends.

As future dividends are not guaranteed, they can be axed at short notice. Thus, I pay close attention to dividend histories, looking for signs of potential pitfalls ahead.

Also, very high dividend yields can warn of future trouble. In particular, history shows that double-digit cash yields rarely last. Either share prices rise and yields fall — or dividends get cut, producing similar outcomes.

The FTSE 100’s highest yielders

For example, here are the FTSE 100’s five highest-yielding shares:

*All figures as of 29 March

Disclosure: my wife and I own shares in four of these five ‘dividend dynamos’ in our family portfolio, excluding Taylor Wimpey. We bought these stocks for their bumper dividend yields. For now, we reinvest this cash into yet more shares, thus boosting our future returns.

Looking at the first three stocks above, I see their dividend payouts as pretty safe. These three asset managers generate billions of surplus capital from their operating businesses, enabling them to comfortably afford projected cash returns. Then again, one of these stocks provides an important lesson in dividend dangers.

Volatile Vodafone

For me, Vodafone Group (LSE: VOD) shares became a classic ‘value trap’. We bought this high-yielding stock in December 2022, paying 90.2p per share. Within two months, the share price had leapt above 102p, but it’s been downhill ever since. Over one year, this stock is up 5.8%, but it has slumped 37.7% over five years.

One problem for Vodafone is that its revenues are either stagnating or growly slowly in its major European markets, including Germany and the UK. Unfortunately, strong growth in emerging markets has failed to offset the group’s long-term earnings decline. At the peak of the dotcom bubble that burst in 2000, Vodafone was Europe’s largest listed company. Today, it’s worth a fraction as much.

One big problem for Vodafone shareholders arrived in May 2024, when the company announced that its yearly dividend would halve from 2025 onwards. Having been €0.09 (7.5p) a year for years, 2025’s payout will plunge by 50%. No wonder the shares have fallen since the loss of this income.

Despite this dividend setback, I remain a fan of CEO Margherita Della Valle, who is turning this tanker around through sales of non-core assets and tie-ups with other telecoms players. Hence, I will keep our Vodafone holding for now!