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Does National Grid plc Pass My Triple-Yield Test?

Like most private investors, I drip-feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.

national gridHowever, the FTSE 100 is up nearly 90%on its March 2009 low, and the wider market is no longer cheap. It’s getting harder to find shares that meet my criteria for affordability.

In this article, I’m going to run my investing eye over National Grid (LSE: NG) (NYSE: NGG.US), to see if it might fit the bill.

The triple-yield test

To gauge the affordability of a share for my portfolio, I like to look at three key trailing yield figures –the dividend, earnings and free cash flow yields, and compare them to the returns available from alternative assets. I call this my triple-yield test:

National Grid Value
Current share price 825p
Dividend yield 5.0%
Earnings yield 6.8%
Free cash flow yield -4.1%
FTSE 100 average dividend yield 2.9%
FTSE 100 earnings yield 5.7%
Instant access cash savings rate 1.25%
UK 10yr govt bond yield 2.7%

A share’s earnings yield is simply the inverse of its P/E ratio. National Grid’s 6.8% earnings yield reflects a P/E ratio of around 15, making it slightly cheaper than the FTSE 100 average.

Of course, National Grid is unlikely to deliver major growth over the coming years, and is mostly chosen as an income stock. Here it scores highly, with a 5.0% yield that the company has committed to increase at least in line with RPI inflation ‘for the foreseeable future’.

Although I’m fairly sure National Grid will keep its dividend promise, National Grid’s free cash flow has been weak over the last couple of years, and has not covered recent dividend payments. The lumpy nature of utilities capex commitments means this isn’t unusual, but it’s still worth watching.

No price freeze for National Grid

National Grid has a crucial advantage over other UK utilities, in my opinion — it doesn’t have to deal with consumers. This means it has been untouched by the political threats made against the big energy utilities over the last six months.

National Grid shareholders can relax — their business isn’t being threatened with price caps or forced break-ups, and National Grid isn’t involved in power generation either, so it doesn’t have to battle against the UK’s chaotic energy policy.

In my view, this all adds up to an attractive income investment, and although National Grid shares aren’t especially cheap at the moment, I think the firm’s inflation-linked 5.0% yield is a good enough reason for income investors to add these shares to their portfolio.

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Roland does not own shares in National Grid.