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Why I’d buy this Neil Woodford dividend grower over National Grid plc

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Softcat (LSE: SCT) pleased the market with its full-year results today and the shares are up almost 5% as I write. The company provides IT infrastructure products and services and the stock is a favourite of well-known fund manager Neil Woodford who holds a good chunk of the firm’s shares under his company’s name Woodford Investment Management Ltd.

Highlights in the figures include revenue almost 24% higher than a year ago and adjusted diluted earnings per share up more than 9%. The directors pushed up the final dividend by 69% and pledged to pay a special dividend on top of that of 13.5p. Because the firm paid a special dividend last year as well, the total payout relating to 2017 rose 15%. At the end of its trading year, Softcat had almost £62m in net cash on its balance sheet to fund the payouts.

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Winning market share

Customer numbers increased 6% during the period and the average gross profit earned per customer put on 6.5%. Chief executive Martin Hellawell puts this success down to “our simple strategy of winning new customers and selling more to existing customers…”  Mr Hellawell reckons that although all the firm’s business lines grew, the security and services businesses stood out, “delivering very strong growth,” as organisations prepare themselves for General Data Protection Regulation (GDPR) compliance enforceable from 25 May 2018. 

Mr Hellawell is set to step down from his role and assume the position of non-executive chairman, but first, the company must find his replacement as chief executive. However, the uncertainty over succession has not upset investors too much and the firm’s financial record is reassuring — both earnings and the dividend appear to be on an upwards trajectory.

Today’s share price around 461p throws up a forward price-to-earnings (P/E) ratio of just over 21 for the year to July 2018, which strikes me as fair for a firm with bright forward prospects. I’m more likely to buy shares in Softcat than in dividend payer National Grid (LSE: NG).

Beware of possible rotation

Many favour the electricity and gas transmission system provider for its monopolistic and defensive qualities. However, the rate of dividend growth has been pedestrian for some time. Over the past four years, National Grid has only managed to raise its dividend around 6% and I think that there are a lot of demands from the capital-intensive business for incoming cash flow.

After rising steadily for several years, the share price faltered during 2016, which could signal the beginning of a valuation adjustment. In uncertain times, defensive firms can be popular with investors, but we could be seeing a rotation out of traditionally defensive firms such as this after valuations became full.

At today’s 931p share price, the forward P/E rating runs at a little under 15 for the year to March 2019. Maybe that’s still rich for a firm that City analysts expect to only deliver earnings growth of 7% for the current year and 4% next year. It wouldn’t surprise me to see the valuation ease further, so I’m avoiding the shares for the time being.

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Kevin Godbold has no position in any of the shares mentioned. 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.

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