While all the headlines at the end of 2015 surround the Federal Reserve’s decision to increase interest rates by 25 basis points, the reality is that high-yield stocks are set to remain in vogue (and in the news) throughout 2016.
That’s because the Bank of England is still some way off taking the decision to increase rates in the UK, with next year set to see the very first upwards move since before the start of the credit crunch. Even then, Mark Carney and his colleagues have been at pains to point out that interest rate rises will be slow, steady and will not risk the health of the UK economy.
The quest for income
As a result, obtaining a 4%-plus yield will still be very important to income-seeking investors, since cash and bonds are simply unlikely to offer much more than they do today when it comes to an income return.
Due to this, utility companies such as United Utilities (LSE: UU) are likely to continue to post strong gains in 2016. That’s partly because United Utilities has a yield of 4.2% and also because it’s forecast to increase dividends per share by 2.1% next year. With inflation standing at around zero, this means that a rising income in real terms is highly likely for investors in United Utilities during the course of 2016.
In addition, United Utilities is likely to benefit from a slow rise in interest rates (as opposed to a fast rise) because of its highly leveraged balance sheet. Certainly, higher interest rates will squeeze profitability at companies with high borrowing levels. But if monetary policy is tightened only gradually then their pricing (as well as investor sentiment) should have adequate time to react.
New revenue opportunities
Also offering excellent income potential is British American Tobacco (LSE: BATS). Its shares yield 4.2% at the present time but, with dividends due to rise by 7.4% next year, its yield is set to rise to 4.4% in 2016. And with dividends being covered 1.35 times by profit, the current level of payout appears to be highly sustainable.
Looking ahead, British American Tobacco has multiple means through which to grow its bottom line. Notably, the increasing popularity of e-cigarettes presents an opportunity for traditional tobacco companies to access a new growth area. Meanwhile the scope for pricing increases in traditional forms of tobacco remains high. In addition, with British American Tobacco trading on a price-to-earnings (P/E) ratio of 16.8, it appears to offer good value for money compared to other global consumer companies. In many cases those other companies offer less resilience than British American Tobacco when it comes to profit growth.
Inflation beater
Meanwhile, Vodafone (LSE: VOD) continues to be one of the most popular income stocks among private investors. That’s at least partly because it has a yield of 5.4%, but also because it has an excellent track record of increasing shareholder payouts in the last five years. In fact, since 2011 they have risen at an annualised rate of 5.3%, which if replicated in future would be highly likely to beat inflation.
With Vodafone’s focus being on Europe, the ECB’s announcement that it may engage in further quantitative easing in 2016 is likely provide the market with confidence in the company’s growth prospects. And with a rise in net profit of 21% due next year, Vodafone seems to be in a strong position to post relatively high returns in 2016 and beyond.