I think BAE Systems (LSE:BA) and the Twentyfour Income Fund (LSE:TFIF) are two top UK dividend stocks for me to buy for my Stocks and Shares ISA in 2022. I found these two stocks by running a screen. First, I looked for stock with a dividend yield between 4% and 8%. Then, earnings had to cover the dividend at least twice over for the current year. Good dividend cover and a debt-to-assets ratio of 0.25 or less suggest dividend safety. If earnings are growing, dividends can increase, so I looked for 5% earnings growth on average.
From the 20+ stocks the screen returned, Twentyfour Income and BAE stood out.
Twentyfour Income Fund
The first thing I do when considering buying a listed closed-end fund like Twentyfour Income is to look at its portfolio. Twentyfour Income holds UK and European asset-backed securities. Half of these are residential mortgage-backed securities, and 40% are collateralised loan obligations. About 23% of the portfolio is rated investment grade, as of the October 2021 factsheet. This fund owns complicated assets that are either unrated by credit agencies or rated below investment grade on the whole. Yields tend to be higher with such assets, but so are the risks. I am comfortable with the complexity and the risk implied by low credit-rated holdings.
Twentyfour income targets a dividend yield of 6%. It was 5.62% in 2021, which is pretty close. Aside from the yield, Twentyfour Income might offer some diversification benefit to my portfolio. The securities it holds tend to pay floating interest rates, so the yield should increase as interest rates rise. A rising rate environment might be damaging for traditional stocks and shares. However, non-investment-grade securities tend to behave just like equities in times of economic stress and offer negligible diversification. On balance, I think Twentyfour Income is a good income generating stock to add to my ISA.
A top UK dividend stock for 2022
BAE was one of the few companies to increase its dividend per share paid during the pandemic. The company has not cut its dividend for over 20 years. Analysts expect the streak to continue as they have forecast BAE to increase its dividend in 2021 and 2022.
BAE is in a strong position within its defence, aerospace, and security industries. Defence spending keeps increasing. Breaking into the industry is difficult, so BAE is one of only a few players. Its revenues have ground higher by 2.8% over the last five years. However, revenue for the company does tend to be a bit volatile. BAE has relatively few customers, and they are typically nation-states. Its revenues depend on large contracts to build warships and the like. These take a long time to complete and pay off in fits and starts, and revenues and profits can swing up and down.
If earnings swing about, then dividend cover can look shaky. Decreasing dividend cover can motivate investors to sell in fear of a dividend cut, only to get back in when it is not. This might explain why the stock has gone sideways for five years. Nonetheless, the forward yield on BAE is about 4.72%, and with a healthy order book to work through, I think BAE’s dividend streak will continue for the foreseeable future. I continue to hold BAE as a top UK dividend stock in my ISA for 2022 and beyond.
James J. McCombie owns shares in BAE Systems and the Twentyfour Income Fund. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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