The perfect dividend stock needs a special mix of profitability, good cash flow and staying power.
Finding companies like these at the right price isn’t easy. For example, ARM Holdings fits the bill, but the high share price and 1% yield means the tech firm isn’t much use for anyone who needs a usable income.
Two companies I believe could make the grade are Royal Mail (LSE: RMG) and AstraZeneca (LSE: AZN).
Royal Mail
Royal Mail shares popped 5% higher this morning, after the postal operator increased its cost-cutting target for the year and reported first-half profits in-line with expectations.
Adjusted operating profits excluding transformation costs were down by £6m to £342m. However, underlying operating costs are now expected to fall by 1% this year, versus a previous forecast for flat costs.
The interim dividend has risen by 4.5% to 7p. Analysts expect a total payout of 21.8p this year, giving a forecast yield of 4.5% at the current 480p share price. This should be covered comfortably by forecast earnings of 34.5p per share.
There was good news operationally, too. While letter volumes continue to decline, Royal Mail’s saw a 4% increase in parcel volumes in its main postal business, along with a 9% increase in volumes in the GLS (Parcelforce) business. This suggests the group may be winning new market share in the all-important online shopping sector.
My only real concern is that the extensive cost cutting being pushed through by chief executive Moya Greene could end up limiting growth potential. In total, 3,000 staff left the business during the first half. The group plans to spend £180m on transformation costs this year, as part of a total investment in the business of £620m. Royal Mail says this is “similar to last year”.
To justify this kind of expenditure, shareholders will need to see decent growth over the next few years.
Notwithstanding this risk, I believe Royal Mail is an appealing income buy following today’s results.
AstraZeneca
When a company receives a takeover offer which then falls through, the share price often drops back to the level it was at before the offer was received.
Interestingly, that hasn’t happened with AstraZeneca shares. The current £44 share price is around 15% higher than the £38 level at which Astra shares traded before Pfizer tried to buy the Anglo-Swedish business.
This suggests to me that the market is confident that AstraZeneca’s pipeline of new products will deliver strong long-term growth. Although profits have fallen heavily since 2011, I believe this long-term view is correct.
Earnings are expected to rise by 11% to $4.25 per share this year, giving a forecast P/E of 16. The dividend is likely to remain unchanged again, but given the 4.1% yield I can accept that for a few years.
One of the things I like most about AstraZeneca is its strong balance sheet. Net debt remains relatively low, at $6.4bn, giving net gearing of only 36%. Cash generation is good, too. On average, the dividend has been covered by free cash flow every year since at least 2009.
AstraZeneca is one of star fund manager Neil Woodford’s biggest holdings. I can see why. For long-term income and growth, I believe these shares are a strong buy.
