Companies in the FTSE 100 index don’t all pay dividends. But some do – and they can be sizeable. Two of the top FTSE dividend stocks right now are Imperial Brands (LSE: IMB) and M&G (LSE: MNG), which offer yields of 9.0% and 8.6% respectively.
Here I explain why I would consider adding both of these top FTSE 100 income picks to my portfolio right now.
The economics of tobacco
Imperial Brands is a tobacco company and owns brands from Rizla to West. Like competitors such as Philip Morris International and British American Tobacco, the company benefits from the simple but lucrative economics of the tobacco industry.
Making cigarettes and other tobacco products is not particularly expensive. The technology is fairly simple and input costs are low, especially as large tobacco makers can achieve economies of scale.
But cigarettes are addictive for at least some smokers. So companies can push through price increases without necessarily losing a lot of sales volume as a result. That means that tobacco can be a highly profitable business, albeit one some investors shun on ethical grounds.
The future of tobacco
One risk to that business model is declining cigarette consumption in some markets. Competitors including BAT are trying to mitigate that by growing their non-cigarette businesses. Imperial is also involved in so-called next gen products, but it has sharpened its focus lately. Its next gen ambitions now look more modest, while it hopes to improve its marketing effectiveness in important markets. That could help it to boost volumes and maintain profit levels.
That could work for now, in my opinion, and the dividend may be sustained. Imperial could maintain its place among top FTSE dividend stocks. But the high yield suggests the City doubts whether it can be sustained in the long term. Focussing on increasing share of a shrinking market looks like managing decline rather than building the foundations for sustainable growth.
I see that as a risk, but I think tobacco has a long runway ahead of it. The 9% yield continues to appeal to me. I would consider adding more Imperial shares to my portfolio now.
Top FTSE dividend stocks: M&G
Unlike tobacco, the outlook for financial services looks pretty rosy in my view. People will continue to need pensions, investment products, and asset management services for the foreseeable future.
Financial services is a complicated, highly regulated market where reputation matters to prospective customers. That means barriers to entry are high, which can help an established name like M&G make profits.
The company has said it hopes to increase or maintain its dividend level, which given its yield makes it attractive to me. A modest dividend increase earlier this year was a sign of management confidence, in my opinion.
But if a high yield possibly signals City worries about sustainability for Imperial, could the same be true for other top FTSE dividend stocks such as M&G? I do see risks. Despite the barriers to entry, well-funded fintechs risk pushing down profit margins across the industry in a fight to win market share. Growing UK inflation could also make some asset classes less attractive, which could hurt revenues in coming years.
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Christopher Ruane owns shares in British American Tobacco and Imperial Brands. The Motley Fool UK has recommended British American Tobacco and 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.