There’s more to successful dividend-led investing than simply choosing the highest dividend yields. I think a decent yield needs to be backed by solid cash flow from a strong business. Ideally, that business should be making progress and growing.
Here are two stocks I’d buy today and hold in my long-term portfolio. I like their potential to pay a dividend income while growing.
2 of the best dividend stocks
AG Barr (LSE: BAG) runs a soft drinks business. The company’s brands include IRN-BRU, Rubicon, Simply, Sun exotic, Funkin, Snapple, Strathmore, Tizer and Strathmore.
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The business has defensive qualities but earnings did take a dent from the coronavirus crisis. In an update released at the end of January, the company said operations “remained strongly cash generative throughout the year” and there’s around £50m net cash in the bank. I reckon such strong finances reflect the quality of the business.
Looking ahead, chief executive Roger White said he expects the months ahead to be “challenging” but he’s “confident” in the firm’s ability to trade through these uncertain times. And part of the director’s Covid response was the halting of shareholder dividends.
But payments should resume in 2021. And with the share price near 497p, the forward-looking yield for this year is about 2.6%. City analysts predict a healthy mid-single-digit percentage increase in the dividend for 2022.
We’ll find out more with the full-year results due on 30 March. But BAG’s strong balance sheet, its defensive operations, and its growth expectations make the dividend attractive to me.
However, if growth fails to materialise (say, through a slower-than-expected return to normal life or a general move towards more ‘healthy’ drinks), the share price could decline from here.
Strong cash flow and a big dividend
Also operating in the fast-moving consumer goods space is FTSE 100 smoking products maker British American Tobacco (LSE: BATS). I think it’s fair to say that smoking is a habit in long-term decline in the western world. And it’s also fair to assume that tobacco companies have lost favour with investors, particularly the big institutions focused on ethical investing. Indeed, the stock has fallen a long way since its peak in the summer of 2017.
But BATS has been growing its market share both organically and via acquisitions when possible. And it’s been doing a good job returning much of its prodigious cash inflow to shareholders with the dividend. City analysts expect the dividend to grow by single-digit percentage increments this year and in 2022.
Part of the company’s strategy is to build up sales of its non-combustible and less dangerous products. However, I reckon the entire industry is vulnerable to legislation and scrutiny that could compromise the business in the future. Perhaps that’s the biggest risk of holding the shares today. And BATS could find itself in trouble because of its big pile of debt.
But with the shares at 2,577p, the forward-looking dividend yield is around 8.5% for 2022. I’d describe that as tempting.
