Income investors turning to high-yielding shares for greater returns should watch out for dividend increases that have been fuelled by a weak pound rather than the strength of the company itself, say experts.

Nine FTSE 100 companies are expected to lift dividend payouts by 20 per cent or more in 2009. But analysis undertaken by The Motley Fool, exclusively for the Financial Times, revealed that in most cases the rises are due only to favourable exchange rates – and could just as easily disappear if the pound strengthens against the dollar.

Audio: Interview

Lucy Warwick-Ching talks to David Kuo from the Motley Fool about the search for dividends

“There are inconsistencies in the market which can be misleading for investors looking for income,” says David Kuo, a director at The Motley Fool. “While it is tempting for investors to choose the shares with the highest increases to dividends, they need to be asking why these dividends have risen by so much and how sustainable those payouts are.

“Although the yields are high, the problem is that if sterling were to strengthen it could mean that the dividend on that share would not be as great.”

This inconsistency was highlighted on Tuesday when BP’s results showed the company’s profits were down 62 per cent but its dividend increased sharply in sterling terms.

“BP maintained its dividend payout but, because of the currency fluctuations, there will be an increase in the dividend payout by almost 40 per cent for UK investors,” said Mr Kuo. “This is because, while last year the exchange rate was almost £2 to $1, the current rate is around £1 to $1.45.”

He makes the point that companies reporting in dollars appear to be boosting their dividends – but this is not necessarily a reflection of the strength of their balance sheets.

For example, Experian could deliver a 44 per cent increase in the dividend payment received by UK investors – from 9 pence in 2008 to 13 pence in 2009. However, in accounting terms, the dividend will remain flat.

The figures from Motley Fool show that, of the nine blue chip companies forecast to significantly hike payouts, only two will actually do so without the help of a weak pound. These are cigarette maker Imperial Tobacco and supermarket giant Morrisons, both of which report accounts in sterling. Imperial Tobacco is expected to increase its dividend by 25 per cent to 79p and Morrison is pencilled in to raise its dividend by 21 per cent to 5p.

Mark Dampier, head of fund research at Hargreaves Lansdown, the UK broker, also warns against the illusory effect of currency fluctuations. “The dollar translation is swings and roundabouts, so it is not something that can be relied upon for a consistent return.”

He suggests investors should note the dividend cover when considering an investment for yield. This is how many times a company’s profits “cover” its dividend payment and is an indicator of whether a company will be able to pay future dividends at the current rate or higher. It is calculated by dividing the net earnings per share by the net dividend per share. The higher the cover, the better the chance of maintaining the dividend if profits fall.

Mr Kuo adds that dividends should only be one factor when picking shares. “For investors looking for consistent returns, it is important to look at other aspects than simply the dividend increase,” he said. “Of course, when interest rates are abnormally low, it is understandable for consumers to seek higher returns for their money elsewhere. But investing in shares for this purpose should only be considered if you can afford to put the money away for at least five years. Any strengthening of the pound could easily wipe out much of these expected gains.”

Source: The Motley Fool. (Notes: Dividend increase based on dividends paid in calendar 2008 and forecast dividend for 2009. yields based on dividend forecast for 2009