ISA’s are one of the best places to save your money. With an extensive array of assets to choose from, and with gains and income sheltered from the tax man, ISAs should be an essential part of every investors’ wealth management strategy.
The biggest benefit offered by an ISA is probably the protection of any investment income from tax. This advantage is especially beneficial for higher rate tax payers, although now the new dividend tax rules have come into force, almost every investor can benefit by using an ISA to shield dividend income from the tax man.
With this being the case, dividend stocks are by far the best ISA investments, companies such as Unilever (LSE: UL) and National Grid (LSE: NG) both of which have a long history of rewarding shareholders.
Lower can be better
It may seem odd suggesting Unilever as a top dividend stock, but the company has all the traits of such a business. Indeed, at the time of writing, shares in Unilever support a dividend yield of 2.9% and the payout is covered 1.5 times by earnings per share. Compared to the FTSE 100 average dividend yield of around 3.5% this payout is not that appealing, but when it comes to dividend longevity, the lower the yield, the better.
Over the years Unilever has always used a conservative dividend policy to reward investors. Management is trying to walk the fine line of paying out enough to keep investors happy but, at the same time, holding enough cash back to support business growth, which over the long term, is better for dividend growth and sustainability.
For example, if the company hits City forecasts for growth over the next two years, between year-end 2018 and 2012 earnings per share will have grown a total of 54%, while the per share dividend payout will have expanded by 61%.
As long as management continue to reinvest in the business, there’s no reason why Unilever’s current level of dividend growth cannot continue.
High payout, low growth
Unlike Unilever, National Grid pays out the majority of its income to investors and while this means the firm’s shares support a yield of 4.5%, over the past five years the per share payout growth has been sluggish. Over the five years to 31 March 2016, the payout expanded by 10%.
Still, as an income investment, you can’t really go wrong with National Grid. The firm owns the majority of the UK’s electricity infrastructure, so its never likely to have any competitors. This means cash flows are stable and predictable, which is great news for dividend investors, as cash flows are unlikely to contract.
To put it another way, National Grid’s earnings are extremely predictable, and it’s unlikely the company will suddenly be forced to cut its payout due to a contract cancellation or low-than-expected sales. That’s why I think the company is the perfect dividend stock.
Make money, not mistakes
The figures above show how important it is for dividends to feature in your portfolio, but most investors apparently ignore these figures as the financial research firm DALBAR recently found that the average investor underperforms the market by 5.3% per annum thanks to poor investment decisions such as ignoring the benefits of dividends.
To help you avoid making the same mistakes, we've put together this new free report entitled The Worst Mistakes Investors Make.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.