2 of the hottest dividend stocks that money can buy

These two stocks could be surprisingly strong income plays for the long run.

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With inflation rising to 2.3%, obtaining high dividends could become a necessity for many investors. While the FTSE 100 yields around 3.7%, its real-terms return is coming under pressure. Therefore, investors may need to consider higher-yielding shares in order to generate a sufficiently high return. Here are two smaller companies which could fit the bill.

Solid progress

Reporting on Thursday was vertically integrated manufacturer of low maintenance building products Epwin Group (LSE: EPWN). Its progress in 2016 was relatively solid despite higher input costs. It has been able to mitigate these following the weakening of sterling, and in the meantime has reported a rise in pre-tax profit of 23.7%. This was boosted by a rise in revenue of 14.5%, while an improvement in the underlying operating profit margin of 80 basis points also enhanced profitability.

With a dividend yield of 6.4%, Epwin is one of the highest-yielding stocks around. Its dividends are covered 2.2 times by profit, which indicates they are sustainable and could rise long term. Certainly, the outlook following the EU referendum is uncertain for its sector. However, with the company trading on a price-to-earnings (P/E) ratio of 7.2, its shares appear to offer a sufficiently wide margin of safety to merit investment.

Looking ahead, earnings growth of 6-7% per annum is forecast in each of the next two years. This shows that as well as income potential, Epwin could prove to be a relatively strong growth stock, too. Its acquisition programme seems to be a sound strategy, while its plans for operational improvements could help to push dividends higher, medium term.

Improving performance

Also offering a relatively high yield is XLMedia (LSE: XLM). It has a yield of 5.7% from a dividend which is covered 1.7 times by profit. This shows that the current payout ratio is sustainable and could even increase at a faster pace than profit over the medium term. Clearly, as a growth company, a relatively large proportion of profit will need to be reinvested, but a dividend coverage ratio, which is slightly lower, could easily be justified.

With XLMedia forecast to record a rise in its bottom line of 9-10% per annum over the next two years, dividend growth is likely to easily beat inflation. The company’s current strategy appears to be working well and its publishing business in particular seems to be growing at a fast pace. It is also enjoying some success at diversifying away from the gambling sector and towards a wider range of industries. Likewise, its largest customer now accounts for 7% of revenues. This reduces its risk profile and could mean its dividend is more robust.

With a P/E ratio of 10.2, XLMedia seems to offer excellent value for money given its outlook. While it is a relatively small company and therefore comes with a degree of risk due to its size, it could prove to be a strong income play over the medium term.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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