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Why I believe these 3 dividend stocks can fund your nest egg

I believe that the best income stocks have three key traits: 1) a market-beating dividend yield that’s well covered by earnings per share; 2) a relatively clean balance sheet and; 3) a record of increasing shareholder payouts. 

Record of dividend growth

Dixons Carphone (LSE: DC) appears to meet all of these criteria. Right now, the shares support a dividend yield of 5.4%, and the payout is covered more than twice by earnings per share. As well as this attractive income stream, the stock also trades at a lowly forward earnings multiple of only 7.6

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With regards to Dixons’ balance sheet, at the end of its last fiscal year, gross gearing (total debt to equity) was 16%, and net gearing (net debt to equity) was only 6.6%. For the fiscal year ending 29 April 2017, the firm generated free cash flow (cash from operations minus capital spending) before dividends of £120m, which easily covered the total dividend distribution of £115m. 

Lastly, the company has an impressive record of dividend growth. Since 2013 the payout has grown at a rate of around 17.6% per year, from 5p per share in 2013 to 11.3p for fiscal 2017. So overall, it looks to me as if Dixons meets all of my income stock requirements. 

Cash-rich balance sheet

Headlam (LSE: HEAD) is engaged in the marketing, supply and distribution of a range of floor covering products, which is hardly the most exciting business, but it pays well. Management has historically returned most of this income to investors, and it does not look as if this trend will change anytime soon. 

Right now the shares support a dividend yield of 5.1%. The payout is covered 1.7 times by earnings per share. Further, Headlam’s balance sheet is exceptionally robust with net cash of £53m at the end of 2016. According to the firm’s figures, the total dividend only costs £23m a year, so even if revenues dropped to zero tomorrow, there would still be scope to maintain the payout for the next two years. 

Over the past seven years, the group has hiked its dividend by just under 10% per annum from 14.2p in 2011 to 23.4p for 2017. Once again, Headlam ticks all of the boxes in my simple top dividend stocks screen. 

Banking income

Shares in Secure Trust Bank (LSE: STB) have fallen by around 20% year-to-date thanks to concerns about the sustainability of its growth as the UK leaves the EU. While the market is worried about the firm’s outlook, analysts do not appear to hold the same view with earnings growth of around 30% per annum pencilled in for 2017 and 2018. 

As well as this earnings growth, the shares support a dividend yield of 4.8%. The payout is covered around 1.5 times by earnings per share. On the balance sheet front, at the end of June, Secure Trust reported a common equity tier 1 ratio of 15.3%, a ratio that’s stronger than that of larger peers such as Lloyds and RBS

So Secure Trust offers an attractive, well-covered dividend yield and has a strong balance sheet but what about dividend growth? Well, since 2012 the bank’s dividend has grown from 57p per share to 79p (estimated for full-year 2017). And considering analysts’ expectations for growth in the years ahead, I believe that this expansion is set to continue. 

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Lloyds Banking Group. 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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