It’s always a good idea to hold some cash for a rainy day. However, when it comes to earning a high income from your capital, interest on cash comes a very poor second to the dividends you can get from investing in the stock market.
At present, the best interest rate available on an easy access Cash ISA is 1.5%. If you invested this year’s £20,000 allowance in such an ISA, you’d receive interest of £300 at the end of the year. The trouble is, with annual inflation running at over 2%, your £20,300 total would actually be worth less, in real terms, than your £20,000 today.
By contrast, many FTSE 100 stocks offer inflation-busting dividend yields, providing investors with a high income, as well as the potential for long-term capital growth. Putting this year’s £20,000 allowance into a basket of income paying stocks in a Stocks and Shares ISA could easily generate an average dividend yield of 5% (£1,000), versus that £300 interest on cash.
Two high-income stocks I’d happily buy today are insurer Phoenix Group (LSE: PHNX), whose shares are trading at 702p, as I’m writing, and tobacco company Imperial Brands (LSE: IMB), with the shares at 2,015p. At these prices, they sport forecast yields of 6.7% and 10.3% respectively.
Rising income star
Phoenix may not be a household name like Aviva, Legal & General or Direct Line, but it’s a £5bn-cap blue-chip, and Europe’s largest life and pensions consolidator. It buys up and runs down ‘closed books’ of life insurance and bulk annuities from other insurers. It does have a consumer-facing ‘open’ business, as a result of its acquisition of Standard Life Assurance, but the products remain branded Standard Life.
For these reasons — and because it’s only recently entered the FTSE 100 — Phoenix is probably still off the radar of many investors. However, I see it as a very attractive proposition for income seekers, with its generous dividend underpinned by multi-billion-pound long-term cash flows from its closed-book business.
The shares are trading in line with the Footsie’s average historical forward earnings multiple of 14, which suggest they’re reasonably priced. But it’s the well-above-average 6.7% dividend yield that persuades me the stock is a great buy for income.
Prodigious free cash flow
Market concerns about declining global tobacco volumes and regulation have led to a big slump in the share price of Imperial Brands. Indeed, the shares are currently changing hands at over 50% below their all-time high of 2016. They’re trading at around half the aforementioned Footsie earnings multiple of 14 and sport that astonishing prospective dividend yield of 10.3%.
Now, while it can’t be denied the company faces volume-growth and regulatory headwinds, I think market pessimism and the share price fall have way overshot the mark. Declining volumes of traditional products and regulation have been headwinds for a good number of years, but Imperial has still managed to grow its revenues.
Furthermore, it continues to generate prodigious, dividend-supporting free cash flow. It’s delivered 10% annual dividend increases over the last 10 years, and the board has said it intends another 10% rise for the current financial year. Despite the generosity of the payout, free cash flow has been so strong that the company’s been able to invest in so-called ‘next-generation products’, while also reducing net debt from a peak of £13.3bn at year-end 2016 to £11.9bn last year. I see Imperial as another great buy for income.
