Buying cheap, unloved stocks can be a great way to build long-term wealth. I’m currently building a list of top FTSE 100 dividend shares that I intend to buy when I next have cash to invest.
I’m searching for companies that meet the following criteria:
- They trade on a forward price-to-earnings (P/E) ratio below the Footsie average of 12 times.
- Dividend yields for the current financial year beat the 4% index average.
Some of the companies I’ve examined appear to be brilliant bargains. Yet others I’ve considered are cheap for good reasons. So which of the following two stocks should I buy, and which would I be better off avoiding?
Forward P/E ratio 4.7 times and forward dividend yield 8.4%.
Banks like NatWest Group (LSE:NWG) have traditionally been popular stocks with dividend investors. The essential financial services they provide mean they have excellent revenues stability. And in normal times this usually translates to hulking great dividends.
But these aren’t normal times. Britain’s bleak economy casts a shadow over profits at cyclical companies like these. So despite its cheapness I have significant concerns over buying the company for my portfolio.
I’m not just concerned about slumping product demand though, nor a steady uptick in bad loans (NatWest’s credit impairments rose to £229m in quarter three from £153m in the previous quarter). I’m also worried about net interest margins (or NIMs) going forwards as speculation rises that interest rates have peaked.
NatWest’s own NIM dropped to 2.94% in the last quarter from 3.13% during Q2. And they may remain under severe pressure as competition in the mortgage and savings sectors increases, and demands for better saver rates from the Financial Conduct Authority (FCA) intensify.
Growing market competition, and the adverse impact of Britain’s struggling economy, make this bank one stock I’m happy to ignore.
Forward P/E ratio 9.7 times and forward dividend yield 6.1%.
Mining stock Rio Tinto (LSE:RIO) is another UK share facing serious near-term trouble. As China’s economy splutters, businesses like this could find it harder to sell their goods.
Despite the danger, I’m considering raising my existing stake in the metals producer. I’m happy to accept the possibility of some near-term turbulence given the potential long-term rewards on offer here.
The company produces a spectrum of metals for which demand is expected to rocket. Rising urbanisation, the technological revolution, and the growing green economy are all tipped to turbocharge the sale of aluminium, copper, and iron ore, to name just a few of Rio’s product categories.
I’m also a fan of Rio Tinto shares because of the firm’s huge financial clout. This gives it extra ammunition to grow through mergers, acquisitions, project expansions and other endeavours.
Indeed, Rio has just signed an agreement with Charger Metals that could see it take a 75% stake in Australia’s Lake Johnston lithium project. The total cost could surpass $50m, though the rewards could be far greater as electric vehicle sales boom.