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2 dividend stocks I’m holding from the FTSE 100 and why

Image: Royal Mail Group. Fair Use.

The FTSE 100’s rise of 11% in the last six months has caught most investors by surprise. After Donald Trump’s election victory, the consensus among investors was that share prices would move lower. However, that hasn’t happened and the FTSE 100 has reached an all-time high. Looking ahead, more gains could be on the horizon. And with inflation edging higher, dividend shares could be the most attractive companies to buy right now.

A dirt-cheap income stock

Royal Mail (LSE: RMG) may not be the most exciting of businesses, but it could prove to be a top-notch income share. It currently yields around 5.6%, which is 190 basis points more than the FTSE 100’s yield. As such, it could become increasingly in-demand as inflation moves higher.

Since Royal Mail’s dividends are currently covered 1.7 times by profit, they appear to be sustainable at its current level of profitability. This indicates that shareholder payouts could grow at a faster pace than profit over the medium term.

Royal Mail’s business is struggling. Its forecasts of flat growth in each of the next two years show that beyond its income outlook, there is little to positively catalyse its share price. However, over the long term its price-to-earnings (P/E) ratio of 10.2 could rise as it gradually repositions its business and drives through efficiencies. Furthermore, potential currency adjustments from its European operations could boost its profitability during the course of the next couple of years.

For investors seeking fast-growing and exciting companies, Royal Mail is unlikely to be attractive. However, for those seeking a dependable, high-yield stock, it could be a strong performer in the long run.

Stable growth prospects

While the stock market is relatively high at the present time, uncertainty could easily build in the second half of 2017. Brexit talks are due to start shortly and President Trump is expected to begin delivering on his ambitious economic plan. Therefore, companies which have enjoyed relatively stable and consistent growth in recent years could become increasingly popular.

One such company is Legal & General (LSE: LGEN). Its earnings have increased in each of the last five years at a double-digit rate. Therefore, it appears to have a sound strategy which could deliver further growth in future. And since its shares trade on a P/E ratio of just 11.3 versus a historic average of 13.6, there appears to be upside potential on offer. In fact, if Legal & General meets its forecasts for the next two years and its rating reverts to its historic average, its share price could move 25% higher.

In terms of income potential, the company’s yield of 6.1% is among the highest in the FTSE 100. Since it is covered 1.5 times by profit, there appears to be scope for it to rise by at least the same amount as profit in the long run. As such, Legal & General appears to have a potent mix of income appeal and capital gain potential for the long run.

Finding the best dividend stocks

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Peter Stephens owns shares of Legal & General Group and Royal Mail. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.