Buying dividend shares is a popular way to generate passive income from the stock market. When vetting dividend stocks to buy, two metrics warrant close scrutiny: the company’s yield and shareholder payout history.
FTSE 100 stalwart National Grid (LSE:NG.) excels in both areas. Not only does the electricity transmission operator offer an index-beating 5.2% yield, but it’s also hiked dividends for an impressive 27 years in a row!
Here’s why I think investors should consider investing in this Dividend Aristocrat today to target a reliable passive income stream.
Private monopoly
One of National Grid’s defining characteristics is its status as a regulated monopoly. Since there’s only one set of transmission or distribution wires in any given area, the company operates without direct competition in its power grid operations across England and Wales.
A monopoly position equips the company with some unique advantages over many firms navigating more competitive landscapes. These include economies of scale, transparent earnings visibility, and consistent cash flows. All great qualities for a dividend stock.
For investors seeking greater portfolio stability amid the rollercoaster of market volatility, owning National Grid shares has a compelling appeal. However, the utility giant’s monopoly status also comes with inherent risks.
Regulated by Ofgem, National Grid is subject to price control mechanisms that restrict its revenue and profit potential. Investment decisions are subject to regulatory oversight too, which means the business isn’t fully in control of its own destiny.
Plus, the possibility of nationalisation, while it looks unlikely today, could be a plausible scenario under a future government.
Indeed, former Labour leader Jeremy Corbyn was mulling such a move only a few years ago. If a buyout were to occur at a depressed valuation, this could potentially destroy significant shareholder value.
Dividend stability
Nonetheless, the passive income that the company provides is a sufficiently attractive reward to compensate for these risks in my view.
National Grid aims to grow the annual dividend per share in line with CPIH inflation. This progressive policy looks especially attractive in light of the significant increase in prices over recent years, which has underscored the gravity of inflationary risks to many investors, myself included.
Granted, despite the firm’s stellar track record, the dividend isn’t guaranteed. Forward cover of just 1.2 times earnings, a capital-intensive business model, and a £46bn debt pile on the balance sheet are all potential causes for concern.
However, National Grid still owns an interest in the UK’s gas transmission system, having already sold off substantial chunks in recent years. Further disposals could help the company meet the costs of updating the electricity network and crucially, protect the dividend from any cuts.
The bottom line
National Grid’s a bona fide defensive stock. It has a strong moat, underpinned by the company’s monopoly position. Plus, I can’t see many credible threats to the demand outlook for electricity transmission and distribution over the coming decades.
There are no certainties in the stock market, but this utility company’s dividend is about as reliable as they come. What’s more, with a forward price-to-earnings (P/E) ratio just above 15, the National Grid share price looks reasonably valued today.
For investors looking to spark up their passive income portfolios, this stock’s well worth considering.
