Every investor needs a selection of large-cap dividend-paying stocks in their portfolio. Indeed, a selection of large-cap income plays forms a backbone for your portfolio, which allows you to take on more risk elsewhere, safe in the knowledge that the dividends will continue to roll in.
National Grid (LSE: NG), Centrica (LSE: CNA) and SSE (LSE: SSE) are three of the best dividend stocks around due to their defensive nature. However, these companies won’t make you a millionaire overnight, but that’s not the point.
With these defensive dividend picks in your portfolio, you’ll receive a steady income that can be reinvested elsewhere. In fact, all three companies have bond-like qualities, making them perfect investments even for the most risk-adverse investor.
Three key qualities
There are three key qualities that all ‘backbone’ companies should have to bring stability to your portfolio. Firstly, the companies in question should have a well-covered dividend yield.
SSE, Centrica and National Grid all easily meet this criterion. Specifically, SSE currently supports a dividend yield of 5.7%, and the payout is covered 1.3 times by earnings per share. Centrica yields 5.8%, and the payout is covered one-and-a-half times by earnings per share, and National Grid currently yield 4.8%. The company’s dividend payout is covered 1.4 times by earnings per share.
Earnings stability
Secondly, companies qualifying for a backbone position should have stable earnings.
Take National Grid, for example — for the past five years the company’s earnings per share have expanded at a steady rate of around 2% to 3% per annum. City analysts expect this trend to continue for the foreseeable future. SSE exhibits a similar quality.
Over the past five years, SSE’s earnings per share have expanded at a rate of around 2% per annum. This growth has been slow and steady with no sudden drops or spikes. Steady earnings growth has supported above-inflation dividend payout growth over the same period.
Unfortunately, Centrica’s growth over the past five years has been much more unpredictable. But now the company is trying to get its house in order.
Centrica did announce a dividend cut earlier this year, but many analysts were expecting the company to make such a move after Centrica’s misguided expansion into the oil & gas market.
Now, Centrica’s dividend payout looks safe for the time being. Payout cover has increased by 30% since the beginning of the year, and the company is curtailing its exposure to the volatile oil & gas market.
Attractive valuation
The third and final quality a backbone stock needs to have is an attractive valuation.
Stocks that trade at a premium valuation to the wider market tend to be more volatile than their cheaper peers. So, if you’re looking for a stable investment, shares with low earnings multiples are your best bets. SSE, National Grid and Centrica trade at forward P/Es of 13.7, 15.9 and 13.1 respectively: the FTSE 100 trades at an average forward P/E of 17.7.
