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The Direct Line share price fall has pushed the dividend up to 10%!

Close-up of British bank notes
Close-up of British bank notes

I invest for dividends, and I always like to have an insurance stock in my portfolio. I currently hold Aviva, on a forecast yield of 6.6%. But the Direct Line (LSE: DLG) share price has fallen 20% over the past 12 months. And that pushes the predicted dividend up above 10% now. I’m thinking of buying.

As we were approaching a threatened recession, financial stocks were falling. Bank and insurance shareholders were looking at increasingly red bottom lines for their 2021 investments.

But here’s a curious thing. It seems that market fear of looming bad news often turns out to be worse than the news itself. Recession has become a reality, perhaps for a couple of years. And financial stocks have started gaining.

Price recovering

When the Direct Line share price bottomed at the end of September, it would have pushed the forecast dividend yield as high as 13%. But 10% is still pretty decent, and I wouldn’t mind taking some passive income from that.

But before I get too enthusiastic, there definitely is some potential downside to Direct Line shares. Even though some uncertainty has been lifted, there’s no shortage of risk around.

Firstly, forecasts are very uncertain at the best of times. But we’re very close to the end of the year now and I see a good chance that this year’s will come good.

Interim dividend

At the interim stage, reported in August, CEO Penny James said: “We are announcing an interim dividend in line with 2021 and are confident in the sustainability of our regular dividends as we look ahead to the full year and beyond.”

Some chill economic winds have been blowing since then though. But in November’s Q3 update, the company told us that “our 2023 and medium-term targets and the outlook for dividend capacity remain unchanged.

Dividend cover

Forecasts for the next couple of years indicate rising earnings, with the dividends remaining stable. If they’re right, it would suggest dividend cover should improve. I definitely want to see that happen, as Direct Line’s cover is not strong.

In fact, 2021 earnings weren’t enough to cover that year’s dividend. And with our current economic outlook, I remain cautious about earnings growth forecasts.

Risk ahead

If we really do get the couple of years of recession that so many are suggesting, I expect the financial sector to come under considerable pressure. And as in any downturn, one way to help keep the balance sheet healthy is to reduce dividend payouts.

The tipsters might see dividends being maintained. But I can’t rule out the possibility of a cut at some point in the next two years. That said, if Direct Line sticks to its dividend plans as it says, I think the shares could turn out to be a very good buy now.

Will I buy? I want to invest further in the insurance sector during the recession, and Direct Line is a firm candidate.

The post The Direct Line share price fall has pushed the dividend up to 10%! appeared first on The Motley Fool UK.

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Alan Oscroft has positions in Aviva. 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.

Motley Fool UK 2022