National Grid shares: are they worth buying for the dividend?

National Grid shares sport a dividend yield of 5.6%. But does that make the stock a good income play?

| 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.

National Grid (LSE: NG) shares are popular among dividend investors as they sport a high dividend yield. Currently, the FTSE 100 stock offers a prospective yield of around 5.6%, which is no doubt attractive in today’s low-interest-rate environment.

Yet, as experienced income investors know, there’s more to dividend investing than just yield. When investing in such stocks, it’s also important to examine factors such as dividend coverage to determine whether the payout is sustainable, as well as dividend growth to determine whether the payout will grow at a rate above inflation. With that in mind, let’s take a closer look at National Grid shares to see how its dividend stacks up.

Low dividend coverage

One thing that does concern me in relation to National Grid is that dividend coverage is quite low.

  FY2018 FY2019 FY2020E
Earnings per share 56.2 58.9 58.4
Dividend per share 45.9 47.3 48.7
Dividend coverage ratio 1.22 1.25 1.20

As you can see, in FY2018 the dividend coverage ratio was 1.22, while in FY2019, the coverage ratio was 1.25. This year, analysts forecast a ratio of 1.2.

Generally speaking, a ratio under 1.5 is seen as risky as it indicates that if earnings were to fall, the dividend payout could be at risk. That’s certainly something to bear in mind if you’re considering NG for its yield. If you’re looking for stocks where there’s very little chance of a dividend cut, there may be better options that National Grid.

Inflation protection

In terms of dividend growth, National Grid’s policy is to raise the dividend payout at least in line with the rate of RPI inflation each year, and it does have a good track record of doing this. For example, over the last five years, it has lifted its payout from 42p per share to 47.3p per share.

This is good news for income investors as it means their income will have kept up with inflation. Looking ahead, analysts expect the payout to grow to 48.7p this year, and 50.1p next year. That’s a positive, however personally, I like to see higher dividend growth of between 5-10% per year.

Risks

It’s also important to think about risks when analysing a dividend stock. Is there anything that could impact the company’s ability to pay its dividend?

In National Grid’s case, my concern is that debt is high and interest coverage (a measure of a company’s ability to pay the interest on its outstanding debt) is low. Interest rates look like they’ll stay low for a while now. However, if they were to rise in the future, this could impact NG’s ability to pay its dividend.

Another issue to consider here is the company has been earmarked for nationalisation by Jeremy Corbyn. However, that does depend on Labour winning an election.

Valuation

Finally, turning to the valuation, National Grid shares currently trade on a forward-looking P/E ratio of 14.8. That’s a little higher than the median FTSE 100 forward P/E of 14.1. I think that’s a fair valuation, but I wouldn’t classify it as great value, given the risks to the investment case.

A good dividend stock?

All things considered, there are other dividend stocks I’d buy over National Grid. Its yield is certainly tempting. However, the low dividend coverage is a concern that cannot be ignored, in my view.

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.

Edward Sheldon has no position in any shares mentioned. 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

After it crashed 25%, should I buy this former stock market darling in my Stocks and Shares ISA?

Harvey Jones has a big hole in his Stocks and Shares ISA that he is keen to fill. Should he…

Read more »

happy senior couple using a laptop in their living room to look at their financial budgets
Investing Articles

How’s the dividend forecast looking for Legal & General shares in 2025 and beyond?

As a shareholder, I like to keep track of the potential dividend returns I could make from my Legal &…

Read more »

artificial intelligence investing algorithms
Investing Articles

Could buying this stock with a $7bn market cap be like investing in Nvidia in 2010?

Where might the next Nvidia-type stock be lurking in today's market? Our writer takes a look at one candidate with…

Read more »

Investing Articles

Is GSK a bargain now the share price is near 1,333p?

Biopharma company GSK looks like a decent stock to consider for the long term, so is today's lower share price…

Read more »

Snowing on Jubilee Gardens in London at dusk
Investing Articles

Could December be a great month to buy UK shares?

Christopher Ruane sees some possible reasons to look for shares to buy in December -- but he'll be using the…

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

Sticking to FTSE shares, I’d still aim for a £1,000 monthly passive income like this!

By investing in blue-chip FTSE shares with proven business models, our writer hopes he can build sizeable passive income streams…

Read more »

Growth Shares

BT shares? I think there are much better UK stocks for the long term

Over the long term, many UK stocks have performed much better than BT. Here’s a look at two companies that…

Read more »

British Pennies on a Pound Note
Investing Articles

After a 540% rise, could this penny share keep going?

This penny share has seen mixed fortunes in recent years. Our writer looks ahead to some potentially exciting developments in…

Read more »