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Why I’d buy top Neil Woodford pick Imperial Brands plc over the FTSE 100

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Neil Woodford has built a reputation as one of the UK’s best fund managers over the years. Unfortunately, thanks to a string of losses, his reputation has taken a bit of a battering this year. 

However, taking losses is just part of investing. A year of bad performances should not detract from Woodford’s two-decade positive run. That’s why I continue to believe that Woodford is still one of the best dividend stock pickers around. 

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A love of dividends 

Following AstraZeneca, the second largest holding in the CF Woodford Equity Income Fund, is dividend champion Imperial Brands (LSE: IMB)

Like Woodford, Imperial has taken a battering this year. Shares in the tobacco giant are down 11% year-to-date, and by 19% over the past 12 months, excluding dividends. 

These declines, while disappointing, have resulted in an excellent opportunity for investors. Imperial is now one of the cheapest consumer goods stocks in Europe, and its dividend yield has risen to 5.5%. Both of these factors indicate to me that the company is a much better buy than the FTSE 100

Under pressure 

Shares in Imperial have come under pressure this year due to growth concerns. Even though analysts are projecting an earnings per share gain of 9% for the fiscal year ending 30 September 2017, followed by an increase of 3% for 2018, the last trading update was more downbeat. 

In particular, the last trading statement noted: “We expect to deliver strong growth in revenues and earnings at actual currency, with constant currency performance impacted by the significant additional investments in the year.” Put simply, excluding the positive impact of weaker sterling on results, Imperial’s earnings could be on track to shrink for the full year. 

Still, despite pressure on earnings, management also noted in the update that “cash generation remains strong“, which to me is a more positive statement. For the six months ended 31 March 2017, the company generated £1.6bn in cash from operations, which easily covered the dividend distribution of £1bn. 

Too cheap to pass up? 

After recent declines, Imperial’s valuation has fallen to just 11.6 times forward earnings, a bargain valuation for such a defensive business. The company’s peer, British American, trades at a forward P/E of 17. 

Further, Imperial’s dividend yield of 5.5% is well above the FTSE 100’s 3.9%. If you bought the index as a whole via a low-cost tracker fund, the income received would be around 3.7% (after including costs), 1.8% less than that offered by the tobacco giant. 

Buying the FTSE 100 as a whole is an option for investors who don’t have the time to research stocks properly. However, while buying an index fund might be a quick fix, it also leaves you overexposed to several large firms that dominate the index. 

For example, HSBC accounts for a staggering 7.7% of the index and just five stocks account for 25%. The FTSE 100 is also currently dominated by sterling. Since Brexit and the collapse in the value of the pound, the index has been on a winning streak. And now it faces the same problem as Imperial; earnings are correlated to sterling. 

The better buy 

Overall, as a cheap income play, Imperial looks to me to be the better buy. The FTSE 100 is a more diversified opportunity. But when it comes to defensive income, Imperial wins hands down. 

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Rupert Hargreaves owns shares in Imperial Brands. The Motley Fool UK has recommended Imperial Brands. 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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