With interest rates on cash savings hitting new lows, I’ve been buying shares in some of the UK’s top dividend stocks to build a passive income.
Today I want to look at two stocks that offer an average forecast yield of 9.1% for this year. They’re quite different businesses, but they both benefit from defensive qualities that I think will continue to support generous dividends.
A 10% dividend yield
My first pick is FTSE 100 tobacco group Imperial Brands (LSE: IMB). Tobacco has long been a popular choice with income investors. However in recent years, ethical concerns, rising debt levels and fears for the future of the tobacco business have damaged Imperial’s reputation as a top dividend stock.
Indeed, the departure of CEO Alison Cooper earlier this year provided an opportunity for the board to cut the payout by one third to a more sustainable level.
You might wonder why I’m suggesting Imperial shares. The answer is that this business continues to generate mountains of cash, and looks far too cheap to me. Even after this year’s dividend cut, Imperial’s share price collapse means that the stock offers a yield of 10.7%.
Such a high yield might normally suggest that problems lie ahead. However, I’ve been following this FTSE 100 stock for years, and I just don’t see that kind of issue here.
I reckon this top dividend stock should climb
Imperial Brands is expected to pay a dividend of about 140p per share this year. My sums suggest that this payout should be covered roughly twice by free cash flow. I estimate this could leave around £1bn of free cash that can be put towards reducing the group’s £14bn net debt.
The £1bn sale of Imperial’s premium cigars business should provide a further boost to the firm’s debt reduction efforts.
IMB stock currently trades on around five times forecast earnings — hence the high yield. Despite concerns about the future of the tobacco business, I think that’s too cheap.
If new CEO Stefan Bomhard can keep the business ticking over and pay down debt, I think Imperial’s high yield will bring in new buyers and lift the group’s share price. I reckon this top dividend stock is a bargain buy at current levels.
27,233 shop owners can’t be wrong
FTSE 250 firm PayPoint (LSE: PAY) provides payment terminals to more than 27,000 small retailers, mostly convenience stores. Services provided by the group’s systems include handling card payments, top-ups, cash bill payments, stock management and sales reporting.
PayPoint also owns the Collect+ parcel drop-off service, which is available at nearly 10,000 locations and handled 24.5m parcels last year.
The company’s large network means there are few alternatives for convenience store owners. Shoppers have also come to expect the range of services available at PayPoint retailers.
This strategy has made PayPoint highly profitable over the years. Indeed, its high profit margins and low levels of debt mean that it generates a lot of surplus cash. Most of this is returned to shareholders through dividends.
I’ve owned PayPoint shares for a while and view this as one of the top dividend stocks in my portfolio. The shares currently trade on 12 times forecast earnings, with a dividend yield of about 7%. I rate PayPal as an income buy at this level.
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Roland Head owns shares of Imperial Brands and PayPoint. The Motley Fool UK has recommended Imperial Brands and PayPoint. 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.