In my opinion, companies that have steady, predictable revenue streams that can be relied upon for many years into the future, make the best dividend investments.
Unfortunately, companies like these are few in number. However, they do exist. Today, I’m looking at two FTSE 100 stocks that both have these qualities.
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On the defensive
The first business I think has attractive dividend credentials is BAE Systems (LSE: BA). The very nature of the defence business makes it unique. Starting such a business isn’t easy and winning contracts is even harder. Those companies that have been around a long time with an established reputation are almost certain to win the bulk of the business. What’s more, contracts in the defence business can last for decades, which gives companies like BAE those steady, predictable revenue streams I mentioned above. The group’s latest significant contract, to build a new fleet of warships for the Royal Australian Navy for example, will generate £20bn for the company over its 30-year life.
The contract with the Australian Navy, and others like it, should mean BAE can maintain its distribution to investors for many decades to come. So I think this is worth a premium valuation.
The good news is, after the recent sell-off, the stock looks cheap, in my eyes.
Right now, shares in the UK’s largest defence contractor are changing hands at a forward P/E of just 11 and support a dividend yield of 4.9%. The distribution is covered nearly twice by earnings per share. So as well as the attractive dividend credentials I’ve laid out above, it also looks as if the business has plenty of headroom to maintain (or even increase) the payout if earnings slide.
All in all, I think BAE is an income investment that’s worth buying and holding forever.
Smiths (LSE: SMIN), in my opinion, has many similar qualities to BAE. It might not be a defence contractor, but its key markets (security and seals) are all highly attractive in their own way.
Even though it’s not the most exciting business in the world, I think Smiths’ seals business (John Crane) deserves extra attention. This division produces seals for pipes and other equipment for markets such as the petrochemical industry. Here, quality is paramount, and customers are willing to pay more to get the right product because the risks are so high. This is just one example of why I think the group will still be around several decades from now.
From an income perspective, the shares don’t look particularly attractive. They currently supported a dividend yield of just under 2%, and command a forward P/E of 19.2. However, I think it’s always worth paying for quality and, in this case, Smiths is a very high-quality company. On top of this, the dividend is covered 2.7 times by earnings per share and has grown as a steady 6% per annum for the past six years.
Put simply, I think it’s worth paying a premium for the company’s quality income.