National Grid (LSE: NG) (NYSE: NGG.US) has a reputation of being a defensive dividend stalwart, which should have a place in any long-term investor’s portfolio.
Indeed, thanks to National Grid’s defensive nature, attractive dividend yield and steady growth, investors have rushed to buy up the company’s shares. The company’s share price has hit an all-time high within the past few days.
But these gains concern me as National Grid’s valuation has skyrocketed. For example, the slow-and-steady utility provider now trades at a forward P/E of 16.6, a valuation that would be more suited to fast-growth tech company.
That’s why I’ve sold my National Grid holding. Instead, I’m planning on buying Persimmon (LSE: PSN) and Taylor Wimpey (LSE: TW) as replacements — due to disclosure rules, I cannot buy just yet.
A good run
As a defensive pick, National Grid is a great company. Nevertheless, my concerns lie with the company’s valuation. In particular, I believe that many investors are looking to National Grid as an alternative to savings accounts, while interest rates remain at rock-bottom levels.
It’s easy to see why, National Grid is a low-risk company and the dividend yield of 4.6% is attractive in this low interest rate environment. Unfortunately, the company’s valuation has been pushed to unsustainable levels.
National Grid’s stellar run could come to a sudden halt if interest rates begin to rise. Indeed, there is some evidence that shows defensive stocks like National Grid, act like bonds when interest rates rise — their price falls.
With this in mind, Persimmon and Taylor Wimpey seem like attractive alternatives. Both companies will support hefty dividend yields, they have strong balance sheets and valuations are low.
Unloved sector
There’s no doubt that UK housing stocks are unloved and valuations are extremely attractive.
Persimmon, one of the UK’s largest housebuilders currently trades at a forward P/E of 11.8 and a 2015 P/E of 9.7. Further, the company is sitting on a net cash balance, reporting cash and equivalents of £326m at the end of the second quarter, up 580% year on year. This cash balance works out at around £1.06 per share.
Along with Persimmon’s attractive valuation, the company is chucking out cash. Specifically, as part of Persimmon’s strategic plan to return £1.9bn to investors, management is planning to pay a special dividend of £0.95p per share next year. City analysts reckon that Persimmon’s dividend payouts will equal a yield of 7.3% during 2015. 
Meanwhile, Taylor Wimpey, another one of the UK’s largest housebuilders, intends to return £250m, or around 7.7p per share to investors during 2015. City forecasts are currently predicting that Taylor’s shares will support a dividend yield of 6.7% during 2015. Despite this lofty yield, the company only trades at a lowly forward P/E of 7.9.
Unfortunately, unlike Persimmon Taylor does not sit on a net cash position as of yet. Taylor’s net debt fell to £36m during the first half of this year, down from £68m during the year ago period — it looks as if Taylor could support a net cash position by next year.
Dividends do best
Dividend income can revolutionise your portfolios performance and is a key part of long-term investing.