Should you buy this FTSE 100 giant for its massive 7% dividend yield?

Rupert Hargreaves runs the rule over what he believes is the best income stock in the FTSE 100 (INDEXFTSE: UKX) index.

| 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.

Shares in tobacco group Imperial Brands (LSE: IMB) currently yield 7% on a forward basis, making the company one of the best income stocks in the FTSE 100. The question is, does this market-beating dividend yield make the stock a good buy for your portfolio? Today I’m going to take a look. 

Out of favour 

Generally speaking, when a stock is trading at a deep discount to the broader market, it is a signal that investors believe the company in question has serious problems. So, it is vital to establish what’s driving sentiment.

Shares in Imperial are currently trading at a forward P/E of just 10.6, compared to the global tobacco sector average of 14.6. They also support a dividend yield of 7%, which is more than double the market median of 3.3%.

Should you invest £1,000 in Enquest Plc 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 Enquest Plc made the list?

See the 6 stocks

The way I see it, two large shadows are overhanging the group — the well-documented decline of smoking and Imperial’s sluggish response to this threat. 

While the company’s peers have been investing heavily in so-called reduced-risk tobacco products (such as heat-not-burn cigarettes), Imperial has been concentrating its efforts on products like electronic cigarettes. The market for these products isn’t small (there were around 3m users of electronic cigarettes in the UK last year), but in contrast to larger peers, Imperial’s spending on diversification has been limited, which is leading some analysts to voice concerns about the group’s long-term outlook. 

Still, concerns that the tobacco industry is on the rocks are nothing new. For the past four decades, tobacco sales have been in decline, but companies have only become more profitable by using tricks such as increasing prices and shortening cigarettes to improve margins. 

Imperial is no exception. Analysts expect earnings per share to rise to 270p for 2019, up from 183p for 2017. If the company hits these targets (and based on its recent trading updates there’s no reason to believe it won’t), analysts think there is scope to increase the dividend 10% per annum for the next two years, giving a dividend of 204p per share or a yield of 7.1% by 2019. With dividend cover of 1.3 times, despite concerns about the firm’s outlook, I believe the dividend is here to stay

Imperial’s dividend looks to me to be sustainable, but one distribution I’m not so sure about is that of FTSE 100 peer SSE (LSE: SSE). 

Reward vs. risk

At the time of writing, shares in SSE support a dividend yield of 7.6%. For 2019, analysts have pencilled in a modest 3.1% increase, which indicates a forward yield of 7.8% is on offer. However, unlike Imperial, which has operations around the world and an operating profit margin of nearly 8%, SSE’s business is located primarily in the UK, and its profit margin of 4.4% (for fiscal 2018) is tightly controlled by regulators. 

I’m always wary of becoming involved with companies that either depend on income from, or are regulated strictly by, the government. Politics can be unpredictable and doesn’t necessarily mix well with business. Recent calls from politicians to nationalise the rail and utility industries are great examples. 

With this being the case, yes the shares in SSE might be cheap (forward P/E of 10.6) but I believe this valuation does not make up for the risks and uncertainties surrounding the business. Imperial offers a similar level of income with a much more attractive risk/reward profile in my opinion.

But this isn’t the only opportunity that’s caught my attention this week. Here are:

5 Shares for the Future of Energy

Investors who don’t own energy shares need to see this now.

Because Mark Rogers — The Motley Fool UK’s Director of Investing — sees 2 key reasons why energy is set to soar.

While sanctions slam Russian supplies, nations are also racing to achieve net zero emissions, he says. Mark believes 5 companies in particular are poised for spectacular profits.

Open this new report5 Shares for the Future of Energy — and discover:

  • Britain’s Energy Fort Knox, now controlling 30% of UK energy storage
  • How to potentially get paid by the weather
  • Electric Vehicles’ secret backdoor opportunity
  • One dead simple stock for the new nuclear boom

Click the button below to find out how you can get your hands on the full report now, and as a thank you for your interest, we’ll send you one of the five picks — absolutely free!

Grab your FREE Energy recommendation now

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.

Rupert Hargreaves owns shares in Imperial Brands. The Motley Fool UK has recommended Imperial Brands. 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

Shot of a senior man drinking coffee and looking thoughtfully out of a window
Investing Articles

Building a second income stream in 2025 is now more important than ever

With the backdrop of today's economic landscape, Mark Hartley investigates the importance of a second income and how to build…

Read more »

Google office headquarters
Investing Articles

Down 29% and 26%, these ‘Magnificent 7’ growth stocks are still on sale!

Both of these mega-cap growth stocks are more than 25% off their highs right now. And Edward Sheldon believes they…

Read more »

Investing Articles

My favourite UK stock is up 365% in 5 years and analysts still say it’s a strong buy!

Harvey Jones loves this top UK stock but was wondering whether it would finally run out of steam. Its response…

Read more »

Investing Articles

Is the stock market going to crash when the tariff window expires?

The stock market’s rallied on news of a 90-day pause to some US tariffs. But could it be set to…

Read more »

Investing Articles

2 investment trusts to help investors become Stocks & Shares ISA millionaires

One of the biggest challenges for new Stocks and Shares ISA investors is which investments to make. Dr James Fox…

Read more »

Investing Articles

The Greggs share price has plummeted for good reason! It’s now a proper dividend stock

Dr James Fox explores whether the beaten-down Greggs share price represents a potential buying opportunity or a value trap.

Read more »

Working from home due to social distancing
Investing Articles

A year ago, £10,000 in Tesco shares — at today’s price — is now worth…

Tesco's provided solid investor returns since April 2024 thanks to strong share price gains and healthy dividends. Can it keep…

Read more »

Investing Articles

Just released: our 3 top small-cap stocks to consider buying in April [PREMIUM PICKS]

Small-cap shares tend to be more volatile than larger companies, so we suggest investors should look to build up a…

Read more »