While there are plenty of companies in the FTSE 100 with bright prospects, I think the best shares to buy are dividend stocks.
There is a straightforward reason why I have this view. Research shows that over the long term, companies that offer a dividend yield tend to outperform other stocks when income is included.
Dividends can be a valuable source of income in a market downturn, providing investors with capital to redeploy and purchase shares at lower prices. This creates a virtuous cycle. Investors can reinvest dividend income to generate more dividend income.
Unfortunately, not all dividend stocks are created equal. For example, some income investors might consider Imperial Brands to be one of the best shares to buy in the FTSE 100. Indeed, it currently offers one of the highest yields in the index at just under 9%.
However, over the past few years, the group has been struggling with elevated debt levels and stagnating profitability. To reduce pressure on the balance sheet, management has already cut the payout. I think a further reduction is likely unless there is a sudden jump in income.
As such, I would stay away from this FTSE 100 company. Nevertheless, I think there are plenty of other income champions in the index, which appear undervalued. Some of these I already own, and others I would be happy to add to my portfolio today.
Shares to buy for dividend income
One of my favourite stocks in the FTSE 100 is the insurance group Admiral (LSE: ADM). I already own shares in this company due, in part, to its income credentials.
Car insurance is a legal requirement in the UK, and Admiral is one of the largest insurance groups in the country. This suggests to me that the business will always have a captive market, which is an excellent quality to have.
As well as its presence here in the UK, the company is also expanding overseas. Its businesses in Spain, France, Italy, and the US are growing rapidly, and last year was the first year they have recorded a small profit.
I think international growth coupled with the company’s UK business should help underpin Admiral’s dividend.
Its management has adopted a unique approach to paying the company’s investors. Rather than targeting a regular dividend every year, management has a regular dividend target and then supplements this with a special dividend. This gives the corporation more flexibility when it comes to setting the distribution. Based on the regular payout alone, the FTSE 100 stock could yield 3.5% this year. Including the special distribution, the yield could rise to 6% or 7%, although this is just speculation at this stage.
Some risks the company may face in the future include higher interest rates, which could impact its investment portfolio. Competition could also hit profit margins in the insurance sector.
FTSE 100 income
I think one of the best sectors to look for income in the current market is the home-building sector. The UK needs to build 300,000 properties a year to meet demand. The country is currently only building around 200,000 a year.
Successive governments have tried to stimulate building with little success. As a result, home prices have increased rapidly, and the demand for new homes remains robust.
Against this backdrop of rising prices and rising demand, builders like Taylor Wimpey, Persimmon, Berkeley and Barratt Developments all look appealing as income investments, in my eyes.
Rather than picking just one of these enterprises for my portfolio, I would buy a basket of all four. And the reason why I would use this approach is simple.
Each of these companies targets a different segment of the market in various regions. Berkeley’s average selling price in its last financial year was £770,000. It primarily builds properties in London and the South East. Persimmon’s average selling price in the first half of its financial year was just £236,000.
By acquiring all four of these companies for my portfolio, I think I could build a basket of some of the best shares to buy for dividend income in the FTSE 100 with added diversification. The stocks support dividend yields up to 8%, and they also have a history of returning excess cash with special dividends.
But risks they may face as we advance include higher interest rates, which could impact demand for new properties. Rising construction costs could also weigh on profit margins.
Income and growth
The final company I want to highlight in this article is Experian (LSE: EXPN). With a dividend yield of 1% at the time of writing, some investors might pass up this stock as an income play. I think that could be a mistake.
The best investors focus on what a business could be, not what it is. Over the past decade, Experian has grown into one of the world’s largest data companies, specifically financial data. This is an industry where reputation and information are more valuable than anything else. As Experian grows, it can develop both its database and reputation, which should lead to profit growth.
Therefore, as the firm’s profits grow, I reckon it should be able to return more cash to investors.
The company’s dividend might not look appealing, but management has always favoured returning cash with share repurchases as well as dividends. Including repurchases, over the past five years, Experian’s total shareholder yield has been around 2%.
Put simply, I am excited about the FTSE 100 company’s growth potential. That is why I think it is one of the best shares to buy today.
While I would buy the stock for my portfolio, I will be keeping an eye on significant risks that could impact growth. These include the potential for a cyberattack, which could hurt its reputation. Competition in the data management sector may also push the company to spend more. This would also have an impact on profit margins.
Rupert Hargreaves owns shares of Admiral Group. The Motley Fool UK has recommended Admiral Group and Experian. 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.