Are Coles or Fortescue shares a better buy for dividend income?

Both of these stocks are compelling picks for dividends.

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Plenty of ASX blue-chip shares are known for being generous ASX dividend shares.

In this article, we have two income-generating shares that most Australians will be familiar with: supermarket giant Coles Group Ltd (ASX: COL) and iron ore miner Fortescue Ltd (ASX: FMG).

Now, the market is always on the move and we typically don't know exactly which way share prices will go. But dividends are much more predictable. A company's payouts are decided by its board and paid for by profits the business has generated.

I'm going to look at a couple of key areas to help me decide which of the two passive income stocks are a better buy for dividends.

Dividend yield

Both Coles and Fortescue have solid dividend yields. A yield is influenced by two things, the dividend payout ratio and the price/earnings (P/E) ratio (which is the earnings multiple valuation).

If a company pays out more of its profit then it will have a higher dividend yield. A lower earnings multiple can push up the dividend yield, while a higher valuation pushes down on the dividend yield.

According to the estimates on Commsec, owning Coles shares could result in a grossed-up dividend yield of 5.8% in FY24, 6.2% in FY25 and 7% in FY26.  

Meanwhile, owning Fortescue shares could mean a yield of 11.2% in FY24, 8.3% in FY25 and 6% in FY26.

In the short-term, Fortescue may offer a bigger dividend yield, but by FY26, Coles could pay a larger dividend yield.  

Sustainability of the payout

This is the most important element to me. I think dividend projections are a sign of what conditions the companies are facing.

According to forecasts, dividend payouts by Coles and Fortescue are tipped to go in opposite directions.

The last few years have been very supportive for Fortescue's shares and profit because of relatively high iron ore prices. But, the iron ore price has dropped back down to around US$100 per tonne – it was above US$140 per tonne in early 2024 and was above US$200 per tonne in 2021.

New supply, particularly from Africa, may be a significant headwind for the iron ore price in the next few years, depending on how much demand there is from China. Of course, Fortescue may have its own African project by then, plus it's diversifying its operations by investing in green energy production.

Coles on the other hand is a very resilient business. As a supermarket business, it provides products that we all need, so the demand is very consistent. On top of that, Australia's population is growing strongly, so the number of potential consumers keeps increasing.

The Coles dividend is much more sustainable, in my opinion. It has grown every financial year since listing on the ASX a few years ago, though past performance is not a guarantee of future performance.

At the current prices, I'd call Coles shares a better buy, particularly as the Fortescue share price is so high despite current weakness in the iron ore price.

Motley Fool contributor Tristan Harrison has positions in Fortescue. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has positions in and has recommended Coles Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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