Shares offering high yields may become more difficult to find as the year progresses. Higher inflation is already here and this could prompt investors to ditch bonds, cash and lower-yielding shares in favour of stocks paying more than the FTSE 100’s yield of 3.7%. Inflation of 3% or even 4% could cause a number of stocks and other assets to offer a negative yield in real terms. As such, buying these two dividend stocks now could lead not only to high income returns, but also capital growth prospects as investor demand for such stocks rises.
Turnaround potential
HSBC‘s (LSE: HSBA) 6% yield is among the highest in the FTSE 100. It’s likely to protect investors from higher inflation during the course of the next couple of years, since it’s unlikely even a fast-rising price level will be ahead of the bank’s yield.
Looking beyond 2018, HSBC’s dividend growth could pick up from the modest rises forecast in the current year and next year. A key reason for this is the bank’s current strategy, which is focused on the delivery of cost savings and efficiencies. They should leave a more streamlined and profitable entity over the medium term. Furthermore, since HSBC’s dividend is covered 1.3 times by profit and earnings are due to rise at a rate of 7% this year and 6% next year, there’s scope for the majority of rising profitability to be passed on to shareholders in the form of a higher dividend.
Clearly, HSBC’s long-term growth is likely to be centred on China and the Asian economy. It offers rapidly rising demand for financial services products. Since the bank is well-placed within that region, it could be a strong performer in future years.
Value opportunity
Royal Mail‘s (LSE: RMG) letters business may be struggling, but it seems difficult to justify the stock’s price-to-earnings (P/E) ratio of 10.4. It may be forecast to report a fall in earnings of 1% in the next financial year, but it has long-term growth appeal thanks to its international operations. They have consistently helped to offset challenges in the UK. And with sterling likely to remain weak this year as Brexit talks start, Royal Mail’s profit outlook could benefit from an additional currency tailwind.
While Royal Mail is unlikely to be considered a quasi-utility as the decline in its letters business continues, its dividend growth forecast of 7.6% in the next two years means it retains its income appeal. It currently yields 5.7% from a dividend which is covered 1.7 times by profit. This shows that while its earnings outlook in the short run may disappoint, it has the capacity to raise shareholder payouts.
Royal Mail’s cost avoidance programme is on target to deliver £225m in avoided costs in the current financial year. This indicates that its overall strategy is sound, which could lead to an improving dividend outlook in future years. When combined with what’s already a relatively high yield, investor sentiment in the stock could improve as inflation moves higher.