With interest rates set to stay low for many years to come, dividends are becoming a more important part of income for a wide range of investors. Of course, there is much more to finding a great income stock than just a high headline yield.
For example, a company may pay a generous dividend now, but if it is unsustainable or unlikely to grow at a brisk pace in future, then it could become far less appealing as an income play. Similarly, a company with a relatively average yield could become a great income investment over the medium to long term, so long as dividend growth is very generous.
On the face of it, then, AstraZeneca (LSE: AZN) (NYSE: AZN.US) appears to be a better income play than United Utilities (LSE: UU) or Stagecoach (LSE: SGC). That’s because it yields 4.3%, which is slightly higher than United Utilities’ 4% and much more appealing than Stagecoach’s rather disappointing 2.8%.
However, AstraZeneca is going through a period of vast change as a result of the loss of patents on key, blockbuster drugs. And, while it is expecting to return to bottom line growth from 2017 onwards, there are no guarantees that the current demise of its profitability will end between now and then. As such, its dividends may be generous, but could turn out to be less secure than many investors would hope for.
That’s where United Utilities has real appeal. It provides water services in the north west of England and offers a very defensive business model. In fact, it is difficult to think of a good or service that has a more consistent level of demand than water, and this enables United Utilities to offer its investors a very robust and stable shareholder experience. This makes its dividend more sustainable than that of AstraZeneca, even though the latter has a lower payout ratio than the former, with United Utilities paying out 87% of profit as a dividend versus 67% for AstraZeneca.
On the topic of payout ratios, public transport company, Stagecoach, has tremendous scope to increase dividends per share. In fact, it has a payout ratio of just 38% and, with its bottom line set to rise by 14% this year and by a further 10% next year, Stagecoach’s dividend increases could be relatively fast. This would not be a major surprise, since the company has increased shareholder payouts at an annualised rate of almost 10% in the last four years, which means that its current yield of 2.8% could move much higher over the next couple of years.
While all three stocks have their own appeal when it comes to income prospects, United Utilities seems to offer the best mix of a high initial yield, sustainability and room for dividend growth. Certainly, AstraZeneca and Stagecoach remain very enticing dividend stocks, but their lack of stability and low initial yield, respectively, count against them. Meanwhile, United utilities continues to be a very obvious and appealing choice for investors who simply want to buy a slice of the company and have the peace of mind of being able to pick up a 4%+ yield every year.
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Peter Stephens owns shares of AstraZeneca and United Utilities Group. The Motley Fool UK has recommended Stagecoach. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.