It may seem rather strange to state that Barclays (LSE: BARC) (NYSE: BCS.US) is a better investment for income-seeking investors than dividend stalwarts, United Utilities (LSE: UU) and Imperial Tobacco (LSE: IMT).
After all, Barclays currently yields just 3%, while United Utilities has a yield of 3.9% and Imperial Tobacco’s yield is even higher at 4.4%. So, over the course of the next year, you will receive a higher income from investing in the latter two.
However, over the medium to long term, Barclays is likely to deliver a greater yield, whilst offering an increased scope for capital gains. Here’s why.
While the headline yield is a major consideration when assessing the income potential of a stock, the potential for dividend growth is arguably even more important. So, while Barclays may yield just 3%, it has huge potential when it comes to increasing the size of its shareholder payouts.
For example, Barclays has a payout ratio of just 34% at the present time and has stated that it intends to increase this to at least 45% in the coming years. Were it to pay out 45% of its current year earnings as a dividend, it would equate to a yield of 3.9% at its current share price. That’s a match for United Utilities and only slightly behind Imperial Tobacco’s yield.
However, working in Barclays’ favour is the fact that other UK banks, such as Lloyds, are aiming to pay out up to two-thirds of earnings as a dividend, which means that Barclays could, in theory, raise its payout ratio beyond its current 45% target over the longer term.
In addition, Barclays is expected to grow its bottom line at a rapid rate over the next two years. In fact, its net profit is due to rise by 35% this year, followed by growth of 22% next year. This provides it with an even greater scope to increase dividends and, when combined with its plans to boost the payout ratio, it means that Barclays is expected to increase dividends per share by 32% next year. This compares favourably to growth of 2.3% at United Utilities and 9.3% at Imperial Tobacco and means that Barclays has a forward yield of 3.9%.
As well as having the scope to increase dividends at a stunning rate, Barclays also has superb capital gain potential. That’s because it trades at a huge discount to the FTSE 100 which, for a company that is set to grow earnings and dividends at a rapid rate, is difficult to justify.
For example, while the FTSE 100 has a price to earnings (P/E) ratio of around 16, Barclays has a P/E ratio of just 11.5 and this indicates that there is significant upward rerating potential. Furthermore, Barclays also offers much better value for money than United Utilities and Imperial Tobacco, which have P/E ratios of 22 and 15.9 respectively.
So, while United Utilities and Imperial Tobacco both have higher yields than Barclays right now, that situation looks set to change over the next few years. While they remain very appealing income stocks and are strong buys at the present time, Barclays offers more growth potential, better value and looks set to become a top notch dividend stock over the medium to long term.
Peter Stephens owns shares of Barclays, Imperial Tobacco Group, Lloyds Banking Group, and United Utilities Group. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.