With UK interest rates set to stay low over the medium to long term, it’s not surprising that many investors are now more focused than ever on high-yield stocks. After all, with most savings accounts offering less than 2% before tax, it is exceptionally difficult to generate a decent income from cash balances.
As a result, shares such as Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) and National Grid (LSE: NG) (NYSE: NGG.US) have become more popular due to their high yields. If you could only buy one of them, though, which should it be?
Yield Differences
An obvious place to start when comparing the relative merits of National Grid and Centrica is their yields. In this respect, Centrica appears to beat its sector peer, even though it recently announced a rebasing of its dividend payouts, with the company cutting the final dividend for 2014 by a whopping 30%.
However, following a savage share price fall, Centrica still yields a very appealing 5.3%, which is way in excess of the present inflation rate of 0.3% and means that you will be able to generate a very generous real terms income by holding its shares.
And, while the same can be said of National Grid, its yield is 0.5% below Centrica’s at 4.8%. Certainly, it is highly appealing — and 50% higher than the FTSE 100’s yield — but on yield alone Centrica appears to be the better income play.
Dividend Cover
Even though Centrica recently reported a disappointing set of results, its dividends are very sustainable at their current level. Certainly, the company’s exploration arm may well continue to experience highly challenging trading conditions, as lower oil prices look set to stay for the medium term. But with a dividend coverage ratio of 1.45, Centrica seems to have sufficient headroom to cope with further disappointment without having to again slash its dividends.
And, while National Grid also has adequate headroom when making shareholder payouts, its dividend coverage ratio of 1.3 is still lower than Centrica’s 1.45. As such, Centrica again seems be a better income play than its sector peer, since it has more headroom when making dividend payments.
Looking Ahead
While Centrica has a better yield and more appealing dividend coverage ratio than National Grid, the latter has a much more stable business model. Unlike Centrica, National Grid carries little political risk and has no exploration arm that will be hit by a continued low oil price. As such, and while its headline numbers may be lower than those of Centrica, it offers a more consistent and reliable dividend that more than compensates for its lower yield and headroom.
So while both stocks seem worth buying if you are an income investor, I think National Grid is the better choice if you can only buy one of them right now.