At last, some good news for savers as cash ISA rates are finally improving. Today’s best variable rate ISA, from Virgin Money, pays 1.45% on £1. Wow. We live in strange times, when 1.45% can be described as market-leading, or a best buy, but that’s where we are.
Turning blue
At the same time, some top blue-chip stocks are offering crazy generous yields of more than 7% or 8%, or even more, with one set to yield 13% in 2019. Shares are riskier than cash, but the potential rewards are far greater. If I had £2,000 to invest right now, I would rather divide it between these two household names than let it languish in a cash ISA.
I’m not going to pretend that Royal Mail Group (LSE: RMG) is without risk. Remember all the hullabaloo about the government under-pricing its shares when it floated at 330p in 2013 amid huge private investor excitement? Today they trade at just 279p, so maybe it wasn’t so wrong after all.
Stale Mail
Yield is calculated by dividing income by share price, so when the share price drops, the yield automatically rises. Royal Mail has fallen 38% over the past 12 months and as a result, now yields a whopping 8.6%, with cover of 1.9. That is an incredible level of income, the question now is whether it is sustainable in the longer run, with cover forecast to fall to just 1.1.
However, management seems committed to its dividend, increasing it in November, despite a 25% first-half drop in operating profits due to lower UK revenue, poor productivity, missed cost avoidance targets and higher than expected cost pressures in its GLS subsidiary.
Ring the changes
Margins are a wafer thin 0.6%, although forecast to widen to 3.3%. Royal Mail currently trades at a bargain price 6.6 times earnings but future earnings growth looks bumpy as it struggles to offset the long-term decline in sending letters. The stock is risky, but the income might just make it worthwhile.
Telecommunications giant Vodafone (LSE: VOD) has also had a rough year, its stock falling 33% which again has driven up the yield, in this case to a dizzying 8.3%. Again, there are questions over dividend sustainability, especially with cover just 0.8, which means it cannot be funded from company earnings, but comes from other sources including debt. That is clearly not sustainable in the longer run.
Another worry is that earnings per share are forecast to fall 15% in the year to 31 March, but things look brighter after that, with a forecast rise of 16% in 2020.
Hold on
Despite holding recent total and interim dividends flat, Vodafone has looked to reassure dividend investors, with the board saying that it will consider increasing the dividend per share over the long term, once it has trimmed its financial leverage.
That came despite swinging from a €1.2bn post-tax profit to a €7.8bn loss for the six months to 30 September, primarily due to a loss on the disposal of Vodafone India (following the completion of the merger with Idea Cellular) and various impairments. Peter Stephens reckons Vodafone’s financial and operational prospects remain sound but do your own research too.