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National Grid shares: are they worth buying for the dividend?

National Grid (LSE: NG) shares are popular among dividend investors as they sport a high dividend yield. Currently, the FTSE 100 stock offers a prospective yield of around 5.6%, which is no doubt attractive in today’s low-interest-rate environment.

Yet, as experienced income investors know, there’s more to dividend investing than just yield. When investing in such stocks, it’s also important to examine factors such as dividend coverage to determine whether the payout is sustainable, as well as dividend growth to determine whether the payout will grow at a rate above inflation. With that in mind, let’s take a closer look at National Grid shares to see how its dividend stacks up.

Low dividend coverage

One thing that does concern me in relation to National Grid is that dividend coverage is quite low.

  FY2018 FY2019 FY2020E
Earnings per share 56.2 58.9 58.4
Dividend per share 45.9 47.3 48.7
Dividend coverage ratio 1.22 1.25 1.20

As you can see, in FY2018 the dividend coverage ratio was 1.22, while in FY2019, the coverage ratio was 1.25. This year, analysts forecast a ratio of 1.2.

Generally speaking, a ratio under 1.5 is seen as risky as it indicates that if earnings were to fall, the dividend payout could be at risk. That’s certainly something to bear in mind if you’re considering NG for its yield. If you’re looking for stocks where there’s very little chance of a dividend cut, there may be better options that National Grid.

Inflation protection

In terms of dividend growth, National Grid’s policy is to raise the dividend payout at least in line with the rate of RPI inflation each year, and it does have a good track record of doing this. For example, over the last five years, it has lifted its payout from 42p per share to 47.3p per share.

This is good news for income investors as it means their income will have kept up with inflation. Looking ahead, analysts expect the payout to grow to 48.7p this year, and 50.1p next year. That’s a positive, however personally, I like to see higher dividend growth of between 5-10% per year.

Risks

It’s also important to think about risks when analysing a dividend stock. Is there anything that could impact the company’s ability to pay its dividend?

In National Grid’s case, my concern is that debt is high and interest coverage (a measure of a company’s ability to pay the interest on its outstanding debt) is low. Interest rates look like they’ll stay low for a while now. However, if they were to rise in the future, this could impact NG’s ability to pay its dividend.

Another issue to consider here is the company has been earmarked for nationalisation by Jeremy Corbyn. However, that does depend on Labour winning an election.

Valuation

Finally, turning to the valuation, National Grid shares currently trade on a forward-looking P/E ratio of 14.8. That’s a little higher than the median FTSE 100 forward P/E of 14.1. I think that’s a fair valuation, but I wouldn’t classify it as great value, given the risks to the investment case.

A good dividend stock?

All things considered, there are other dividend stocks I’d buy over National Grid. Its yield is certainly tempting. However, the low dividend coverage is a concern that cannot be ignored, in my view.

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Edward Sheldon has no position in any 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.