With all the talk about interest rates potentially going up before or after the general election in May 2015, it feels as though it’s more important than even for income-seeking investors to find companies that pay a generous yield.
Indeed, for interest rates to increase, it is more likely than not inflation will be higher than its current level of 2%, thereby reducing the real income (that above and beyond the level of inflation) which investors currently receive.
For instance, if inflation is currently 2% and the yield of the FTSE 100 is 3.5%, the real yield is 1.5%. However, if interest rates increase to 1% and inflation heads north then it is clear that the real yield could quickly be wiped out.
Fortunately, the utility sector still offers yields that are more generous than those of the wider index, in part due to the policies of the Labour opposition. Indeed, comments made about freezing prices and putting in place a regulator with sharper teeth have pinned back the prices of utility shares, meaning there could be some bargains to be had.
One stock that could provide a fillip to income-seeking investors is National Grid (LSE: NG) (NYSE: NGG.US). It currently offers a yield of 5.4%, which is a premium of 53% to the FTSE 100 yield of 3.5%.
Furthermore, National Grid does not suffer from the same degree of political risk as sector peers SSE and Centrica, since it does not supply electricity directly to the end-consumer. Therefore, it could be the case that National Grid’s share price is being unreasonably held back by concerns surrounding the wider utility sector.
As a result, it could be argued that National Grid is undervalued and, assuming the current yield premium is not maintained, shares could be worth rather more than their current price.
Indeed, if shares were to trade on a (still generous) yield of 4.5%, it would mean they still offer a premium of 28.5% versus the FTSE 100 yield and trade at 940p, which is around 19% higher than their current share price.
Add to this a yield of 5.4% and it’s clear that National Grid could be an income stock worth holding, as interest rates (and, possibly, inflation) rise over the coming years.
> Peter owns shares in National Grid.