Dividend yields can be both tempting and deceptive. The average yield across the UK market sits at around 3.3%, which is a fair return for many investors. However, income-focused companies often maintain yields of between 6% and 7%, and that’s generally considered healthy.
The tricky part comes when yields stretch far higher. A simple rule of thumb is that the yield should ideally be less than double the 10-year gilt yield. If it’s much more than that, it could be a warning sign that the income looks too good to be true.
It’s also important to dig deeper than the headline number. Is the company generating enough earnings and cash to support those payouts? Does it have a sensible level of debt? And perhaps most crucially, is there long-term demand for its products or services?
With those questions in mind, here’s one FTSE 250 stock I think is worth a closer look.
TwentyFour Income Fund (LSE: TFIF) is a closed-ended investment company that focuses on riskier but higher-yielding UK and European securities. Typically, such securities cover things like credit card debt and mortgages held by smaller banks and credit unions.
Right now, the fund boasts a dividend yield just shy of 10%. For investors targeting passive income, a stock like this could give a major boost to the overall portfolio yield.
That said, it’s no use if the share price drifts lower or if dividends get slashed. Encouragingly, this fund looks more stable than many of its high-yield peers. The payout ratio currently stands at a sustainable 79% and the fund has built an impressive track record. Nine years of consistent payments, including five straight years of dividend growth, suggest management’s committed to shareholders.
The share price has also remained remarkably steady. Over the past decade, it’s traded in a tight band between 100p and 120p, which is unusual for such a high-yielding vehicle.
Add to that minimal debt, strong cash flow and a valuation that looks fair, with both the price-to-earnings (P/E) and price-to-sales (P/S) ratio sitting at around 7.5.
Based on those factors, there seem to be plenty of reasons for investors to consider this fund.
Of course, there are risks to check out. TwentyFour Income Fund invests in structured credit products, including sub-investment grade tranches of asset-backed securities (ABS) and residential mortgage-backed securities (RMBS). That means if the underlying borrowers default, the fund’s income could take a hit.
This isn’t a fund for the faint-hearted. Exposure to these asset classes can be rewarding, but they carry greater uncertainty than traditional corporate bonds or blue-chip dividends. Investors need to weigh up the risk and reward carefully.
