With inflation falling to minus 0.1%, the prospect of a brisk rise in interest rates seems to be fading. That’s because the global economy continues to experience a deflationary period and, if rates move upwards too quickly, it could cause deflation to spiral and the knock-on effect may be reduced GDP growth or even a recession.
As a result, dividends are likely to be hugely important to many investors in the coming years and, with the FTSE 100 yielding almost 4%, there are a number of top notch income plays on offer at highly enticing prices.
For example, tobacco stocks such as British American Tobacco (LSE: BATS) and Imperial Tobacco (LSE: IMT) offer yields of 4.3% and 4.5% respectively. While impressive figures, the most appealing reason to buy shares in both companies is their dividend sustainability, with them having very stable businesses which are likely to grow profitability in the mid to high-single digits over the medium term and pass much of that earnings growth on to investors in the form of higher dividends.
Certainly, the tobacco industry is changing and the advent of e-cigarettes has the potential to shake up the established order. The reality, though, is that the likes of British American Tobacco and Imperial Tobacco already have exposure to that market and, with them having such strong cash flow and being so financially sound, they could easily conduct M&A activity so as to dominate the e-cigarette space as they do in the tobacco market.
And, while they trade on premium price to earnings (P/E) ratios of 17.2 (British American Tobacco) and 14.8 (Imperial), there is still room for upward reratings when their valuations are compared to other global consumer stocks – many of which have P/E ratios in excess of 20.
Meanwhile, retailers such as Sainsbury’s (LSE: SBRY) and Debenhams (LSE: DEB) also have huge dividend appeal, although they are far less stable prospects than their tobacco peers. That’s at least partly because they are subject to much greater competition, with the likes of no-frills supermarkets such as Aldi and Lidl eating away at Sainsbury’s market share, while lower cost options have also caused a reduction in profitability at Debenhams in recent years, too.
Still, both companies yield 4% and, looking ahead, dividends could grow at a brisk pace. That’s because the UK economy continues to improve, with unemployment recently reaching an all-time low. And, with inflation being at or near-zero, consumers are enjoying rising disposable incomes in real-terms for the first time since the start of the credit crunch.
Clearly, both Sainsbury’s and Debenhams are enduring a relatively challenging period. But, with dividends being covered twice and 2.3 times respectively by profit, their sustainability as income stocks appears to be relatively high. And, with P/E ratios of just 12.5 and 10.9 respectively, there is clear upward rerating potential, too.
