With inflation rising to 2.7% last month, dividend yields look set to become more important to investors. After all, with cash balances and investment-grade bonds generally offering negative real-terms yields, shares could become a rare source of a positive real-terms income return. As such, it would be unsurprising for dividend stocks with high yields to see their share prices increase due to higher investor demand. Here are two FTSE 100 stocks which could fall neatly into that category.
An uncertain future
With a dividend yield of over 6%, SSE (LSE: SSE) offers an income return which is well in excess of the rate of inflation. Furthermore, the company is seeking to increase dividends per share by at least as much as RPI inflation over the next three years. This could mean that its shares remain popular among income-seeking investors. That’s especially the case due to the company’s solid track record of financial performance.
Of course, there is uncertainty ahead for SSE. Both major political parties have proposed price caps on energy tariffs, which could hurt its profitability and ability to pay rising dividends. However, with SSE trading on a price-to-earnings (P/E) ratio of just 12.5, the risks it faces seem to be priced in. Furthermore, the company’s dividend appears to be highly sustainable at its current level – even if earnings dip slightly in the short run. SSE has a dividend coverage ratio of 1.4, which suggests it can afford to pay out a slightly higher portion of profit as a dividend each year.
With a mix of a high yield and low valuation, there appears to be a sufficiently wide margin of safety to merit investment at the present time.
Although British Airways owner IAG (LSE: IAG) currently yields less than the FTSE 100, its dividend growth potential is high. As such, a dividend yield of 3.5% could easily rise to surpass the FTSE 100’s yield of 3.8%.
Certainly, there is scope for further challenges in the European airline sector, where a higher supply of flights and lower demand have caused some challenges for IAG. However, with the company having a sound strategy, it is forecast to report a return to growth next year. Its bottom line is expected to rise by 7%, which is due to push dividends per share 8.4% higher.
Beyond next year, more dividend growth is on the cards due to the company’s relatively low payout ratio. It currently pays out around 27% of profit as a dividend each year. While some profit will need to be reinvested for future growth, IAG could feasibly pay out a higher proportion of earnings as a dividend without jeopardising its future growth rate. With a price-to-earnings growth (PEG) ratio of 1, now could be the perfect time to buy a slice of the business ahead of a potentially fast-rising dividend.
Peter Stephens owns shares of SSE. The Motley Fool UK has no position in any of the shares mentioned. 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.