It’s always a good idea to hold some cash for a rainy day. However, when it comes to earning a high income from your capital, interest on cash comes a very poor second to the dividends you can get from investing in the stock market.
At present, the best interest rate available on an easy access Cash ISA is 1.5%. If you invested this year’s £20,000 allowance in such an ISA, you’d receive interest of £300 at the end of the year. The trouble is, with annual inflation running at over 2%, your £20,300 total would actually be worth less, in real terms, than your £20,000 today.
By contrast, many FTSE 100 stocks offer inflation-busting dividend yields, providing investors with a high income, as well as the potential for long-term capital growth. Putting this year’s £20,000 allowance into a basket of income paying stocks in a Stocks and Shares ISA could easily generate an average dividend yield of 5% (£1,000), versus that £300 interest on cash.
Two high-income stocks I’d happily buy today are insurer Phoenix Group (LSE: PHNX), whose shares are trading at 702p, as I’m writing, and tobacco company Imperial Brands (LSE: IMB), with the shares at 2,015p. At these prices, they sport forecast yields of 6.7% and 10.3% respectively.
Rising income star
Phoenix may not be a household name like Aviva, Legal & General or Direct Line, but it’s a £5bn-cap blue-chip, and Europe’s largest life and pensions consolidator. It buys up and runs down ‘closed books’ of life insurance and bulk annuities from other insurers. It does have a consumer-facing ‘open’ business, as a result of its acquisition of Standard Life Assurance, but the products remain branded Standard Life.
For these reasons — and because it’s only recently entered the FTSE 100 — Phoenix is probably still off the radar of many investors. However, I see it as a very attractive proposition for income seekers, with its generous dividend underpinned by multi-billion-pound long-term cash flows from its closed-book business.
The shares are trading in line with the Footsie’s average historical forward earnings multiple of 14, which suggest they’re reasonably priced. But it’s the well-above-average 6.7% dividend yield that persuades me the stock is a great buy for income.
Prodigious free cash flow
Market concerns about declining global tobacco volumes and regulation have led to a big slump in the share price of Imperial Brands. Indeed, the shares are currently changing hands at over 50% below their all-time high of 2016. They’re trading at around half the aforementioned Footsie earnings multiple of 14 and sport that astonishing prospective dividend yield of 10.3%.
Now, while it can’t be denied the company faces volume-growth and regulatory headwinds, I think market pessimism and the share price fall have way overshot the mark. Declining volumes of traditional products and regulation have been headwinds for a good number of years, but Imperial has still managed to grow its revenues.
Furthermore, it continues to generate prodigious, dividend-supporting free cash flow. It’s delivered 10% annual dividend increases over the last 10 years, and the board has said it intends another 10% rise for the current financial year. Despite the generosity of the payout, free cash flow has been so strong that the company’s been able to invest in so-called ‘next-generation products’, while also reducing net debt from a peak of £13.3bn at year-end 2016 to £11.9bn last year. I see Imperial as another great buy for income.
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G A Chester has no position in any of the shares mentioned. 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.