This 7% yielder looks a bargain after today’s positive update

Pearson (LSE: PSON) has released a positive update todat that shows it’s moving in the right direction following a very challenging period. It also shows that its 7% yield could become even more appealing over the medium-to-long term.

Tight cost management is the key for Pearson at present. It’s facing difficulties in its markets, which has caused a 7% reduction in sales for the first nine months of the current financial year. However, Pearson has been able to achieve more than 90% of the growth and simplification programme it announced in January. This is expected to save the company up to £350m in costs, with £250m of them set to be delivered in 2016 and a further £100m in 2017.

Going digital

Alongside this cost reduction, Pearson is investing in digital products and services. This includes five new Connections virtual charter school partnerships and its second online degree partnership in the UK. This could boost Pearson’s long-term growth, but in the short run it’s expected to gain from a weaker pound. In fact, if the pound stays at its current level through to the end of 2016, Pearson’s earnings could be boosted by 4.5p per share to as much as 59.5p per share.

However, its shares are down 10% today due to a slowdown in the key US market. This was partly because of an expected decline in assessment revenue in the US, but also because of declines in North American Higher Education courseware over the summer. Since then, improving trends have persisted in September and October, but investor sentiment appears to have been hit by this disappointing news.

With Pearson on track to meet its 2016 guidance, its dividend is due to be covered 1.1 times by profit. This is clearly not a large amount of headroom, but Pearson’s bottom line is forecast to rise by 16% next year and this means that dividends should be covered a healthier 1.2 times by profit. While this still means that rapid dividend rises may not be on the cards in the short run, Pearson’s improving financial performance could positively catalyse shareholder payouts over the medium-to-long term.

Stability counts

Of course, Pearson is still in a period of major change and its dividend is clearly not well covered right now. For investors seeking a more stable dividend stock, National Grid (LSE: NG) remains a sound choice. Its business model is highly resilient and is far less dependent on the performance of the wider economy than is the case for Pearson. Furthermore, in uncertain times many investors flock to defensive stocks such as National Grid, which means that it could provide increased stability to a portfolio.

With National Grid yielding 4.2% from a dividend covered 1.5 times by profit, it offers a more certain outlook for income investors. Therefore, it’s the better buy of the two companies, although Pearson still has considerable appeal as an income stock.

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Peter Stephens owns shares of National Grid. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.