I’m often asked what are the best dividend stocks to buy with people typically looking for the highest yields. High yields are obviously good, but they can often happen because of short-term share price weakness, they might not be well covered, or they might not be sustainable.
If you’re investing for the long term, I reckon there are two key things to look for in a dividend, strong cover by earnings and a history of progressive annual rises.
Challenger bank
Virgin Money Holdings (LSE: VM) has only been a listed company since November 2014, so its track record is relatively short. But since its first dividend in 2015, of a modest 4.5p for a 1.2% yield, it’s been growing well ahead of inflation.
A 13% hike in 2016 followed by a further 17% last year took the yield to 2.1%. And though that initial rate of growth can’t be expected to continue, analysts are still forecasting a 6% uplift this year followed by another 9% in 2019. That would bring the yield up to 2.6%.
That’s clearly well ahead of inflation, but is Virgin Money likely to maintain this impressive start and get actual yields up to something decent? I think so, for several reasons.
Firstly, in these early days the bank’s dividend policy has been very conservative, with 2018’s expected payment more than six times covered by earnings. By contrast, Lloyds Banking Group has a predicted 5.3% yield, around twice covered, and Barclays‘ 3.1% would be covered three times.
If Virgin were to go for cover of three times this year, we’d be looking at dividend yields of 4.4%, with twice cover yielding 6.6%. But right now, the cash is better spent on growing the business.
This year is off to a strong start, with first-quarter gross mortgage lending of £1.4bn and net lending of £0.2bn in line with expectations. Retail deposits are doing better than expected, and overall full-year guidance has been confirmed.
Chief executive Jayne-Anne Gadhia spoke of “10.4% year-on-year growth in our mortgage book,” and that’s from a small bank in a big market with plenty of room for further growth.
Decades of growth
If you’re looking for a terrific long-term record, they don’t come much better than my second pick, RPC Group (LSE: RPC).
One of the world’s leading suppliers of rigid plastics packaging and plastic containers, RPC has upped its annual dividend for 25 years in a row. And with forecasts suggesting further earnings growth, analysts are expecting serious inflation-busting dividend rises of 15% this year and 9% annually for the following two years.
If that proves accurate, this year’s mooted 3.4% yield would climb to 4.1% by 2020, with dividends covered around 2.5 times by earnings.
On top of these attractive dividends, RPC has been handing back further cash to shareholders via a £100m share buyback programme since July 2017. It hasn’t actually made much difference to the share price in a year, but it is up 160% over five years. And the shares are trading on what I see as a very tempting P/E multiple of 11.3, dropping to 9.9 on 2020 forecasts.
Again, this year is looking good so far, after March’s trading update told us the “positive trading trends outlined in the third quarter update have continued, and revenue for the full year is expected to have grown significantly versus last year.“