Investors in Direct Line (LSE: DLG) have enjoyed a prosperous year, with shares in the company making gains of just over 20% while the FTSE 100 has struggled to post any gains, being up less than 1% at the time of writing. Does this mean, though, that Direct Line has become too expensive and is no longer an attractive income play? Or is Direct Line still a super income stock?
A Great Income Play
On the face of it, Direct Line looks like a great income play. Shares currently yield a whopping 5.1%, which easily beats the FTSE 100’s yield of 3.5% and is also well ahead of inflation and the best interest rates that high-street banks can offer.
However, what really sets Direct Line apart from the pack as a great income play is the forecast dividend growth rate, in combination with the yield. For instance, Direct Line is forecast to increase dividends per share at an annualised rate of 10.5% over the next two years. This is ahead of the FTSE 100 average and means that (if its price does not change), Direct Line could be yielding as much as 6.2% in 2015.
Of course, Direct Line could be being overly-generous with its dividend and the result of this could be a precarious financial position. However, the company’s payout ratio suggests that it is not following that path and is, moreover, ensuring there is sufficient capital to reinvest in the business so as to fuel future growth. For instance, the dividend payout ratio in 2013 was a very healthy 50% and, it could be argued, this payout ratio should be higher. Indeed, Direct Line seems to have the scope to pay a greater proportion of profits as a dividend, which would be great news for income-seeking investors.
Looking Ahead
Trading on a price to earnings (P/E) ratio of just under 10, Direct Line seems to offer good absolute value but also good relative value, since the FTSE 100 currently has a P/E of around 13.5. As a result of this and its strong yield, impressive dividend per share growth prospects and the potential to pay a greater proportion of profits as a dividend, Direct Line really is a super income stock.
