Why I think these downtrodden income stocks will recover

Our writer considers two income stocks that have recently had their dividends slashed. He believes the good times will return.

| 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.

Rainbow foil balloon of the number two on pink background

Image source: Getty Images

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.

With inflation putting a squeeze on my finances, I take comfort from having income stocks in my portfolio. I try not to worry about short-term market movements. Instead I console myself that whatever is happening in the UK stock market, the dividend payments will keep on coming.

Recently, a number of well-known companies have cut their dividends. Given the slowdown in the UK economy, this is to be expected. But I’ve take a look at two of them, to see whether this is a temporary blip, or an indication of a more fundamental problem.

Building

In July 2022, when Persimmon (LSE:PSN) last paid a dividend, its stock was yielding 13.2%. The company declared 235p a share for its 2021 financial year. In 2022, this was reduced to 60p. This year, the directors have stated that they want to “at least maintain” the payout to shareholders.

Should you invest £1,000 in Boohoo Group right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Boohoo Group made the list?

See the 6 stocks

The construction sector is particularly vulnerable to rising interest rates and the consequences for household incomes.

Last year, Persimmon completed 14,868 houses. But towards the end of the year, there was a marked slowdown in sales enquiries and its order book started to shrink. Although it’s too early to make accurate predictions, the expectation is for 8,000-9,000 completions in 2023.

Based on the current number of shares in issue, a dividend of 60p per share would cost £192m. Even with a 50% collapse in earnings this year, it should be well covered by the company’s profits. As a proportion of profit before tax, it’s much lower than some previous payments.

It therefore might be a case of under-promising and over-delivering.

YearDividend (pence)Profit before tax (£m)Cost of dividend (£m)% of profit paid as dividend
20182351,09174869
20191101,04135134
202023578475096
202123596775078
20226073119226

Insurance

The directors of Direct Line Insurance Group (LSE:DLG) decided not to pay a final dividend after announcing a poor set of results for 2022.

The company’s operating profit fell from £590m in 2021, to £32m in 2022. The 95% reduction in earnings was blamed on soaring inflation and unusual weather.

The company’s solvency ratio (a measure of financial stability) fell from 160% to 147%. It’s still above the required 100%, but the trend is downwards.

In May 2022, the stock was yielding 8.9%. Now it’s 4.7%.

In my view, the problems affecting the insurance company are unlikely to last. Inflation is expected to fall, which means increases in the cost of repairing damaged vehicles will ease. An increase in premiums will also offset this.

Last year was particularly bad for storms, and extremes of hot and cold temperatures. This resulted in a higher level of claims than anticipated. Although not impossible, it’s unlikely that this will be repeated in 2023.

And since the end of 2022, the company has become more solvent.

What do I think?

I’d be comfortable having both of these income stocks in my portfolio.

In fact, I already own shares in Persimmon. And despite the problems at Direct Line, its stock is now on my watch list for when I’ve some spare cash.

Both stocks look relatively cheap to me. Their current share prices reflect the expectations of lower profits. But as the economy recovers, and inflation eases, both should see their earnings rise. Increased payouts to shareholders should then follow.

Finally, I can see that even after their dividend cuts, the stocks are presently offering a better yield than the UK stock market average.

Of course, there are plenty of other passive income opportunities to explore. And these may be even more lucrative:

We think earning passive income has never been easier

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.

James Beard has positions in Persimmon Plc. The Motley Fool UK has no position in any of the shares mentioned. 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

Here’s why Tesla stock just rocketed 22.7%! Is it time to buy?

This writer wonders whether the news that sent Tesla stock soaring yesterday is a true gamechanger for the electric vehicle…

Read more »

Investing Articles

2 quality UK stocks to consider buying as share prices rally

With UK stocks moving higher, it might look as though investors with cash on hand have missed their chance. But…

Read more »

Investing Articles

How much £10,000 invested in Lloyds shares is forecast to be worth in 12 months

Harvey Jones is looking past today's stock market volatility to see where Lloyds shares may stand in a year's time.…

Read more »

Investing Articles

How Warren Buffett stays ahead of the stock market

When share prices fall, everyone suddenly wants to be like Warren Buffett. But what’s the secret to the Berkshire Hathaway…

Read more »

Investing Articles

Cheap UK dividend shares to consider buying right now

We're only just past the first quarter of 2025, but it already looks like the year could be another good…

Read more »

Young Asian woman with head in hands at her desk
Investing Articles

What the heck is going on with the Barclays share price now?

The Barclays share price surged 25% as the market open on 10 April. Once again, the volatility’s been driven by…

Read more »

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

What the devil’s going on with the HSBC share price?

The HSBC share price has actually been less volatile than some of its peers, despite its Chinese operations suggesting it’s…

Read more »

Young Black woman looking concerned while in front of her laptop
Investing Articles

Are Tesco shares a screaming buy after sinking to 9-month lows?

Tesco shares continue to experience price weakness as signs of mounting competition grow. But is it now too cheap to…

Read more »