Few market participants would dispute the idea that dividend investing is an excellent strategy for growing wealth over the long term. The only bone of contention is which high-yielding companies to hold.
Last week, my Foolish colleague Edward Sheldon compared one big oiler with a pharmaceuticals giant. This weekend, I’m doing exactly the same thing with two more highly traded stocks: power provider National Grid (LSE: NG) and communications giant Vodafone (LSE: VOD).
It’s fair to say that both companies have never been slouches when it comes to returning cash to their owners. Last year, National Grid returned 45.6p per share to holders, equating to a 5.2% yield at its current share price. Vodafone dished out 15 euro cents per share — a yield of 6%.
So, it’s simple — we should all buy Vodafone? Hold on there.
Recent dividend growth
In addition to looking at the size of dividends on offer, it’s worth checking whether companies are growing their payouts year-on-year. Consistent annual hikes to the dividend are indicative of a healthy business and confident management. Conversely, stagnant or declining payouts are a signal that things could get nasty.
On this front, Vodafone has a less than perfect record with payouts dipping three times over the last five years. National Grid, on the other hand, increased its dividend four times between 2012 and 2017, albeit by only a couple of percent each time.
Chunky payouts are all very well. As many experienced income investors know, but what looks a great investment today can quickly become a weight around holders’ necks if a business struggles to generate sufficient cash flow to pay its bi-annual or quarterly dividends. That’s why it’s so important to check the level of dividend cover before adding a company to your portfolio.
According to Stockopedia, Vodafone’s dividend cover of just 0.61 for the current financial year implies that at least some of its payout will be paid for from reserves. National Grid’s payouts, by contrast, are covered 1.3 times by profits — a lot more comforting.
In terms of valuation, National Grid looks a clear winner. Right now (and following a period of price weakness), you can pick up the FTSE 100 constituent’s shares for a little under 15 times forecast earnings. That’s not screamingly cheap but nor is it outrageously expensive. Top tier peer Vodafone, on the other hand, currently changes hands for almost 29 times earnings. Chalk up another point to the Grid.
Since the past is no guide to the future, it’s worth looking at where payouts from both companies are likely to go from here.
Based on its share price today, owning a slice of National Grid will bag you a 5.3% yield in the current year, rising to 5.4% in 2018/19. Vodafone’s payout comes in at 5.6%, albeit with the lower cover mentioned above. This is forecast to rise to 5.7% the following year.
Positively, the recent revision to full-year guidance for earnings before interest, tax, depreciation and amortisation (EBITDA) from 4%-8% to “around 10%” suggests Vodafone’s dividends could become more sustainable in time. Nevertheless, with its virtual monopoly, there’s a lot to be said for the security that a company like National Grid offers investors.
All told, I’d be far more inclined to buy shares in National Grid at the current time over those of Vodafone.
Is your portfolio prepared for Brexit?
Thanks to its defensive properties, I think National Grid could be an excellent stock to buy and hold in preparation for the UK's eventual separation from the EU. Unfortunately, the same can't be said for other stocks.
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Paul Summers 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.