When income investors seek high-yielding stocks, they traditionally look for them in defensive sectors, such as utilities, healthcare and consumer non-cyclicals. But with many stocks in those sectors seeing slowing growth, it may be wise to look elsewhere for high yielding opportunities.
A favourite among yield-hungry investors is National Grid (LSE: NG). The utility giant pays an attractive dividend yield of 4.6%, but growth is low and valuations are pricey. Underlying EPS is set to grow by just 4% this year, and its forward P/E is 15.7. What’s more, the company has a high leverage ratio (net debt-to-EBITDA), currently 4.9x, which means future interest rate hikes would likely have a significant impact on earnings and lead to an even slower rate of dividend growth.
Cyclical risks
Cyclical stocks may be riskier income investments because their earnings depend very much on the state of the economy, but many domestically focused stocks are doing well because of the robustness of the UK economy. In particular, I like two UK housebuilders, Taylor Wimpey (LSE: TW) and Berkeley Group Holdings (LSE: BKG).
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The cyclical nature of the housebuilding sector means investors will always worry about the next property crash. Recent signs show the property market is beginning to slow, but this should not be too much bad news for housebuilders. The number of new home sales and average property values continues to trend upwards, and demand for housing will likely outstrip supply for years to come.
Low valuations, fast growth
Taylor Wimpey and Berkeley have seen their earnings grow by double-digit rates over the past three years, and this has led to steady cash flow generation and a strengthening of their balance sheets. Both companies now have sizeable land banks and having healthy net cash positions.
Based on current figures, Taylor Wimpey’s prospective dividend yield for 2015 is 5.3%, and dividends are expected to grow by around 10% annually over the next two years. Analysts believe that Taylor Wimpey is set to return between 32-33 pence per share to shareholders over the next three years. That is worth around 17% of its share price, which is a staggering figure for a company that still has double-digit growth.
Valuations are attractive, too, with shares trading at a forward P/E of 12.4, based on analysts’ estimates of underlying EPS growth of 32% this year. In 2016, its forward P/E is forecast to drop to just 10.9, as analysts expect underlying EPS will grow by another 15% to 17.0p per share.
Dividend surprise?
Berkeley’s forward P/E is slightly more expensive, at 13.1. But, this is because of the uneven timing of completion for some of its larger development projects, which is set to cause earnings to fall 6% in 2015/6. On the upside, earnings growth is set to re-accelerate to 52% in 2016, giving it a consensus estimate for underlying EPS in 2016/7 of 276.5p per share. This would give it a forward P/E for 2016/7 of just 8.5, which is lower than many of its peers in the sector.
The company plans to return 434p per share over the next three years, which represents an annual forward dividend yield of 4.6%. But, as the company is holding net cash worth 9% of its market capitalisation and generating a free cash flow yield well in excess of 10%, Berkeley could afford to pay more cash to its shareholders than it already plans to do. So, unless the company goes on an investment spree (which seems unlikely), Berkeley could surprise investors with an even more ambitious dividend policy.
