Why I’d avoid this dividend stock and buy 6% yielder BP plc instead

Roland Head highlights key progress at BP plc (LON:BP).

| 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.

I believe it’s time for investors to get choosy about dividend stocks. With the FTSE 100 trading at the lowest levels since December 2016, there’s plenty of choice for income hunters.

A quick review of the big-cap index shows around 40 stocks with a forecast yield of at least 4%. If you expand your search to include the FTSE 250 as well, that number rises to about 100.

Today I’m looking at two dividend stocks I’d like to own at the right price.

Passive income stocks: our picks

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

A mixed picture

In my opinion, energy services firm John Wood Group (LSE: WG) — now known as ‘Wood’ — is a good company. But last year’s £2.2bn acquisition of rival Amec Foster Wheeler will take a while to digest.

The Wood share price was down by 5% at the time of writing, after the firm’s 2017 results revealed a full-year loss of $30m, thanks to $165m of one-off costs.

These figures show that the group’s pro forma revenue — adjusted to include Amec Foster Wheeler for comparison purposes — fell by 12% to $9,882m last year. Proforma adjusted operating profit fell by 11% to $598m. Adjusted operating margin was unchanged at 6%.

Looking at the actual figures, Wood ended last year with adjusted earnings of 53.3 cents per share, 16.8% lower than in 2016. Despite this, the dividend was increased by 3% to 34.3 cents per share.

Too soon to buy?

I’m confident that as the oil and gas market recovery continues, earnings will improve. I’m also fairly comfortable that the group’s management will do a decent job of integrating Amec Foster Wheeler, which is expected generate cost savings of $170m over three years.

However, the Amec deal has left the combined group with net debt of $1,646.1m. This equates to 2.4 times earnings before interest, tax, depreciation and amortisation (EBITDA).  The company aims to reduce this to between 0.5x and 1.5x EBITDA “within approximately 18 months”. I believe this could be challenging.

Earnings are expected to rise by 16% this year, putting the shares on a forecast P/E of 13.5 with a prospective yield of 3.7%. This could be good entry point. But with debt reduction a priority, I don’t think there’s any rush. I’d watch for opportunities to buy below 600p.

Why I’d snap up this 6% yield

Services companies like Wood have yet to see the full benefit of the oil market recovery. But producers such as BP (LSE: BP) are already one step ahead. They’ve cut costs and are enjoying surging profits thanks to higher oil prices.

BP’s underlying earnings are expected to rise by 40% to $0.44 per share this year. This should provide additional support for the dividend and enable the group to start reducing its debt levels.

Forecast dividend cover of 1.1x earnings is still slim, but it means the payout will be covered by earnings for the first time since 2015. I believe that hitting this milestone means the dividend should be safe for the foreseeable future. The $0.40 per share payout could even start to rise over the next few years.

BP’s share price has fallen by nearly 15% since January. Trading on a 2018 forecast P/E of 15 with a prospective yield of 6.1%, I rate the stock as a strong buy for income.

Our best passive income stock ideas

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

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.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended BP. 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.

More on Investing Articles

Investing Articles

This FTSE AIM stock has £2.3bn in net cash, and a market cap of £2.4bn!

I love this FTSE AIM stock, but it really hasn’t delivered for me yet. The stock trades with crazily low…

Read more »

Smart young brown businesswoman working from home on a laptop
Investing Articles

Down 15% in a week! Are these 5 FTSE 100 fallers screaming buys as markets plunge?

Five of Harvey Jones's favourite FTSE 100 stocks all have the same thing in common – they've fallen around 15%…

Read more »

Hand of person putting wood cube block with word VALUE on wooden table
Investing Articles

2 stocks that have been crushed and now offer a ton of value

Edward Sheldon has been scanning the market for stocks that offer value after the sell-off. Here are two shares he…

Read more »

Light trails from traffic moving down The Mound in central Edinburgh, Scotland during December
Investing Articles

£10,000 invested in Aston Martin shares at Christmas is now worth…

Aston Martin shares have fallen from above £10 in early 2020 to pennies today. Is this the perfect time for…

Read more »

Mindful young woman breathing out with closed eyes, calming down in stressful situation, working on computer in modern kitchen.
Investing Articles

Up 5% in the last crazy week! Are these 2 income stocks the ultimate FTSE defensive plays?

Harvey Jones picks out two FTSE 100 dividend income stocks that have actually climbed while stock markets are heading in…

Read more »

British flag, Big Ben, Houses of Parliament and British flag composition
Investing Articles

2 beaten-down UK shares that now look really cheap

Looking for cheap shares to consider for the long term? These two British stocks offer a lot of value right…

Read more »

Middle-aged white man pulling an aggrieved face while looking at a screen
Investing Articles

As stocks tank, is this a rare chance for ISA investors to get rich?

Shares have collapsed globally and valuations are becoming, on paper at least, a lot more attractive. Dr James Fox explores…

Read more »

Investing Articles

2 strong FTSE 100 dividend shares to consider as recessionary risks increase

Looking for secure passive income stocks to consider buying as thumping trade tariffs loom? Here are two FTSE 100 dividend…

Read more »