When it comes to income investing, utility stocks such as National Grid (LSE: NG) (NYSE: NGG.US) have an obvious appeal. They tend to offer high yields and a relatively defensive business model, which could be viewed as an ideal formula for dividend-seeking investors.
However, with its shares falling by 2.3% today as the onset of a higher interest rate environment in the US starts to be factored in, will National Grid really work out as an income play?
Higher Interest Rates
Although interest rates in the US (and possibly the UK) are set to increase later this year, their rise is unlikely to be a rapid one. After all, the world economy remains a highly uncertain place with, for example, a Greek exit from the Euro a very real possibility and something that has the potential to hurt the performance of stock markets on both sides of the ponds.
So, the weakness in utility stocks such as National Grid that has been seen in recent days is likely to be a short term phenomenon. That’s because, while higher interest rates will mean higher interest charges on their debts, this may not prove to be a major problem for utility companies since the rate of increase is likely to be somewhat modest.
Dividend Growth Potential
As well as a yield of 4.9%, National Grid also offers a highly enticing dividend growth target. In fact, the company is aiming to increase the amount it pays to shareholders by at least as much as inflation over the medium term. This may not sound like such an appealing prospect while inflation is just 0.5% but, with the full effects of quantitative easing yet to be felt, it could prove to be a real asset over the long run.
Defensive Characteristics
Certainly, a rising interest rate may peg back the capital gains on offer with National Grid but, with its yield still being hugely appealing and dividends growing by at least as much as inflation, it is unlikely to see its share price fall significantly.
After all, even if interest rates reach 2-3%, a dividend yield of over 4.5% is still relatively appealing and this should provide National Grid’s share price with a degree of support moving forward. And, in the long run, paying interest on debt while base rates are at 2-3% still makes borrowing a relatively cheap activity, thereby lessening the impact of higher interest charges on investor sentiment.
So, while market sentiment in National Grid may be slightly weaker at the present time, its top notch yield and dividend growth plans still make it a super income stock.
