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£5k to invest? I’d buy these 5% dividends for a Stocks and Shares ISA

Governments don’t often provide us with a free pass to make tax-free profits. But that’s exactly what the ISA system allows us Britons to do, saving up to £20,000 each year in a tax-free savings account.

Interest rates on cash savings are so low that the tax advantage provided by Cash ISAs is now pretty minimal. But the lesser-known Stocks and Shares ISA still provides huge potential savings on tax for long-term investors.

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The majority of my investments are held in a Stocks and Shares ISA. This should mean that long-term gains will be exempt from capital gains tax. And in the future, I should be able to use my dividends to provide a tax-free income.

Today I want to look at two dividend stocks with yields over 5% that I think would be excellent long-term ISA buys.

Buy only the best

If you only invest in shares when everything seems rosy, you’ll often end up paying a high price for good companies. This tends to reduce your future returns.

If you’re willing to start buying when others are selling, you can often find some real bargains. One company I think looks good value at the moment is FTSE 100 commercial property REIT Landsec (LSE: LAND).

Formerly known as Land Securities, this firm’s share price has fallen by 33% over the last four years. Investors are worried about problems in the retail sector and the possible impact of Brexit.

These are valid concerns. But I think we need to keep them in proportion.

The group’s £13.8bn property portfolio includes £6.6bn of prime London office space. In total, the firm’s property assets generated a net rental income of £618m last year, £7m more than in the previous year.

After costs, this was enough to lift the group’s underlying profit by 8.9% to £442m, comfortably covering last year’s dividend.

Why I’d buy today

As I write, Landsec stock is trading at 830p. That’s 38% below the company’s net asset value of 1,339p per share.

This discounted valuation has pushed the stock’s dividend yield up to 5.7%, well above the FTSE 100 average of about 4.5%. I believe Landsec’s discounted valuation and continuing profitability makes it a cracking buy at current levels.

Defensive profits

Another stock on my buying radar is FTSE 250 aerospace and defence company Babcock International Group (LSE: BAB).

This group has been out of favour with investors, who’ve feared a repeat of the problems that have affected other big outsourcing companies. However, Babcock’s high-end engineering skills and its focus on defence makes this a different kind of business, in my view.

So far, the firm has not suffered the kind of problems we’ve seen elsewhere in the outsourcing sector. Indeed, recent trading has been positive, in my opinion. Last year saw the group’s underlying per-tax profit edge 1% higher to £518m, while debt levels fell.

Management said that trading is in line with expectations so far this year. The long-term outlook has been strengthened thanks to the firm’s selection as preferred bidder for a £1.25bn contract to build five warships for the Royal Navy.

The Babcock share price has risen since I last covered this business. But the shares still look cheap to me, trading on 7.5 times forecast earnings with a 5.5% dividend yield. I continue to rate the stock as a buy.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Landsec. 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.