With interest rates falling to new lows, dividends matter even more to many investors. Bond yields, interest on cash balances and property income are being squeezed, and a logical place to turn is high-yield shares such as Imperial Brands (LSE: IMB) and GlaxoSmithKline (LSE: GSK), which yield 3.8% and 4.7% respectively. However, it is their dividend growth potential that is of even greater significance.
Imperial Brands
Imperial Brands is forecast to increase its dividends per share by 10.4% in 2017. This may sound like a very generous increase in shareholder payouts, but it is below the forecast growth in the company’s earnings, which are expected to increase by 12% next year. This means that Imperial’s payout ratio will fall to around 63% next year.
This level of payout may sound high. For many companies it would indicate that there is little scope for a major increase in the proportion of profit that is paid out as a dividend. However, for a mature tobacco company, a 63% payout ratio is very low since it benefits from high barriers to entry, constant demand for its products and minimal reinvestment requirements.
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Therefore, it would be unsurprising for Imperial to increase its payout ratio to over 80% over the medium term. This would put it on a yield of 4.8% using this year’s earnings forecast.
Imperial also benefits from growth potential within the e-cigarette space. It acquired leading e-cigarette brand blu and this could act as a positive catalyst on its earnings and dividends in future years. Alongside its consistent sales and profitability from tobacco products, this makes Imperial a top notch income stock with excellent dividend growth potential for the long term.
GlaxoSmithKline
Unlike Imperial, GlaxoSmithKline’s payout ratio is exceptionally high. It currently stands at 83%, which is high for a company that requires a significant amount of reinvestment in order to develop new treatments. In fact, GlaxoSmithKline plans to freeze its dividend over the next couple of years so as to improve its financial standing. This means that its current 4.7% yield may not increase for existing shareholders over the medium term.
However, beyond that, GlaxoSmithKline has stunning dividend growth potential. Its pipeline is diverse and holds the potential for multiple blockbuster drugs. For example, its ViiV Healthcare division offers high sales growth potential and could positively catalyse GlaxoSmithKline’s future profitability.
GlaxoSmithKline’s appeal extends to its defensive nature. It is far less reliant on the wider macroeconomic outlook than is the case for the majority of its index peers. This means that even if Brexit causes problems, the US election ends with significant uncertainty and US interest rates choke off the economic recovery, GlaxoSmithKline is still very likely to be able to afford to make dividend payments. Alongside its high yield and long term growth potential, this makes it a star income play at the present time.
