At the start of July, National Grid (LSE: NG) shares were trading at nearly 1,000p. But over the next week, these gains were lost, with the share price dropping to around 850p. It currently trades at 870p. So at this low price, is it the perfect time to buy?
What caused the National Grid share price drop?
Two things caused this share price fall. Firstly, its dividend of 32p per share went ex-dividend on 2 July. This means that shareholders who buy the stock on or after the ex-dividend date are not entitled to the upcoming payment, and the stock will trade without its subsequent dividend value. It’s therefore no surprise that the share price headed downwards. This is also the case when any stock goes ex-dividend, so the drop in the National Grid share price on this date is not a surprise or a worry.
More of a worry for National Grid shareholders was the news that Ofgem is planning to cut customers’ bills. This means that less of the consumer’s money will go towards the company’s profits, and more will be used for service and infrastructure improvements. The firm subsequently said it was “extremely disappointed” by the announcement. As a result, National Grid shares fell nearly 6% on the day.
So why buy now?
While this recent announcement may hit National Grid profits, it is still a very reliable stock. People will always need power, and as a natural monopoly, National Grid is in a leading position to provide this. But future growth could be slow, so it is not as a growth stock that I would buy. Instead, National Grid shares tempt me purely for income.
After the recent pullback, the dividend currently yields 5.6%. This is especially tempting as so many other FTSE 100 companies have recently cut or cancelled their dividends. The company also adopts a policy of increasing its dividend by at least as much as RPI inflation each year, and this was the case again this year, despite the difficult economic climate.
But while this is a strong dividend, and the payment this year demonstrates its reliability, I do have some concerns. Firstly, profits have actually fallen in recent years. For example, operating profits in 2016 totalled over £4bn, whereas last year they were only £2.78bn. Seeing as dividends are paid from the company profits, it therefore seems unsustainable that the dividend can continue rising unless profits also increase. I cannot see significant profit growth, especially after the recent Ofgem announcement. In addition, there is over £30bn of debt on the balance sheet. This is compared to just £2bn of cash, and £19bn of shareholder’s equity. Such a large amount of debt is a risk moving forward, and the company will need to address this.
The final analysis
All in all, I’m not buying National Grid shares after the recent dip. Although I think that the dividend and share price should remain stable over the next few years, I prefer an income stock with growth opportunities as well.
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Stuart Blair 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.