BAE Systems plc, Severn Trent Plc & Pennon Group plc: Are These The Safest Dividend Stocks?

Do shares in BAE Systems plc (LON:BA), Severn Trent Plc (LON:SVT) & Pennon Group plc (LON:PNN) offer slow and steady growth?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Income-hungry investors who have been tempted by the high yields of mining giants BHP Billiton and Rio Tinto are seeing their dividend investing strategy backfire, casting doubt over the wisdom of chasing after yield.

But, investors need to realise that depending on cyclical sectors to pay steady dividends was always going to be a risky strategy. Volatile commodity prices and demand which fluctuates according to business cycles meant free cash flows needed to fund dividends were never going to be dependable for long.

Until recently, many investors thought BHP Billiton and Rio Tinto were exceptions. They believed that because they were some of the lowest cost producers globally, they could always generate enough cash flow to pay consistently high payouts. With hindsight, we can now see how this was wishful thinking.

Defensive sectors

Defensive sectors have always been better places to look for reliable dividend stocks. Though not completely immune to dividend cuts, these companies tend to generate more stable cash flows with whatever economic conditions thrown at them.

BAE Systems (LSE: BA) is one such defensive stock. Hit hard by defence spending cuts in recent years, the company is now making a recovery. Sales and operating profits are expanding at their fastest paces in five years, growing 7.6% and 15.5%, respectively, in 2015. Robust growth is coming from both defence and civilian markets, with growth markets, such as cyber security, intelligence and electronics, offsetting slowing demand for military hardware.

Looking forward, recovering defence budgets in key US and European markets should lead to continued revenue and earnings growth, underpinning a steady outlook on dividends. BAE’s 4.2% dividend yield seems secure, as it is covered by almost 2.0x earnings; it is also supported by a strong balance sheet, with net debt of just £1.4bn.

Water utilities

Shares of water companies have long been seen as reliable dividend investments. This is because the predictability and transparency of their regulated revenues and capex plans means these companies can estimate with a high level of accuracy their future free cash flows.

Nevertheless, water companies are not free from risk. Every five years, Ofwat, the water regulator, conducts a price review to set out what they must commit to deliver during the period and the price they may charge customers. After its 2015 review, Severn Trent (LSE: SVT) made a 5% cut to its dividends this year, in order to fund a 5% cut in average household bills by 2020.

Severn Trent and Pennon Group (LSE: PNN) have another four years before their next regulatory review, giving investors a very high degree of visibility over dividend payments until then.

Shares in Severn Trent and Pennon Group both yield 3.9%, but Pennon has a slightly better dividend outlook. Pennon has pledged to increase its dividend by 4% above RPI inflation until 2020, whilst Severn Trent is just targeting above RPI inflation growth.

These stocks may not be the highest yielding ones on the market today, but they are relatively attractive compared to other safe forms of investments, such as savings and bonds. And unlike most other safe assets, water stocks act as a good hedge against inflation.

What’s more, with expectations that the Bank of England will delay raising interest rates until well into 2017, or possibly later, these reliable dividend stocks should remain in favour for longer than many analysts had previously expected.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended Rio Tinto. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Here’s how I’m using a £20k ISA to target £11k+ in income 30 years from now

Is it realistic to put £20k in an ISA now and earn over half that amount every year in passive…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

If I could only keep 5 UK stocks from my portfolio I’d save these

Harvey Jones is running through his portfolio of top UK stocks to see which ones he couldn't bear to do…

Read more »

Midnight is celebrated along the River Thames in London with a spectacular and colourful firework display.
Investing Articles

I’m aiming for a million buying unexciting shares!

By investing regularly in long-established, proven and even rather dull businesses, this writer plans to aim for a million. Here's…

Read more »

Investing Articles

3 things to consider before you start investing

Our writer draws on his stock market experience to consider a few vital lessons he would use to start investing…

Read more »

Investing Articles

Will this lesser-known £28bn growth stock be joining the FTSE 100 soon?

As the powers that be plan a reorganisation of Footsie listing rules, this massive under-the-radar growth stock could find its…

Read more »

Investing Articles

Fools wouldn’t touch these 5 FTSE 350 flops with a bargepole – how come I own 3 of them?

Harvey Jones took a chance on three struggling FTSE 350 stocks in the hope that they'd stage a dramatic recovery.…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

How I’m trying to make a million from passive income

Invest as much as possible, regularly, and use the passive income to plough back into more shares. Here's how millionaires…

Read more »

Investing Articles

I’d buy 30,434 shares of this UK dividend stock to target £175 a month in passive income

A top insider has spent over £1m buying this 9%-yielding passive income share over the last year. Roland Head explains…

Read more »