With savings interest rates hitting new lows, interest in dividend stocks is stronger than ever.
In this article, I’ll compare the attractions of FTSE 100 income giants GlaxoSmithKline (LSE: GSK) and Legal & General Group (LSE: LGEN). Both companies are long-term favourites of star fund manager Neil Woodford, but which is the best choice for investors in search of a reliable income?
Positioned for growth?
Shares in GlaxoSmithKline have risen nearly 20% since the EU referendum caused the pound to plummet. While Glaxo’s trading is unlikely to be affected by Brexit, the firm reports its earnings in pounds. The weaker pound means that overseas earnings will be worth more than expected.
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In July’s interim results, Glaxo said that if exchange rates remained unchanged from the end of June, core earnings per share would rise by 19% this year. This is good news for dividend investors, as it should mean the firm’s 80p per share dividend will become more affordable.
However, currency tailwinds can rapidly reverse. I think it’s best to make sure a stock has other attractions before investing. The good news is that Glaxo’s investment in new products and restructuring is also starting to generate stronger profits.
Even before the referendum, City consensus forecasts for this year’s earnings had risen from 84p per share in December, to 88p in May. The latest forecasts are for earnings of 96.3p per share this year, rising to 101.6p in 2017.
Although analysts’ forecasts often lag events, my view is that the trend indicated by monthly changes is a useful guide to the performance of the underlying business. Consensus forecasts for Glaxo’s 2016 earnings have now risen every month since January. That’s a decent record.
Glaxo stock currently trades on 17 times forecast earnings and offers a prospective yield of 4.8%. I don’t think that’s cheap, but I agree with Neil Woodford’s view on the long-term growth potential of big pharmaceuticals businesses.
As a long-term income play, I think Glaxo remains a buy.
These shares could be oversold
Insurance and savings giant Legal & General is down by 21% so far this year, despite having bounced back from a post-referendum low of 160p.
The market remains bearish on Legal & General, despite the firm’s assurances that Brexit won’t affect its business. My view that the shares have probably been oversold was strengthened by the group’s recent interim results.
During the first half of 2016, Legal & General’s net cash generation — roughly equivalent to free cash flow — rose by 16% to £727m. Earnings per share rose by 24% to 11.27p, comfortably in line with full-year forecasts of 20.7p per share.
The dividend is expected to rise by 5.5% to 14.1p this year. This should be adequately covered by both net cash generation and earnings, so looks pretty safe to me.
Like GlaxoSmithKline, Legal & General should benefit from the world’s ageing populations and increasing levels of welfare spending. Its shares currently trade on just 10 times forecast earnings, and offer a prospective dividend yield of 6.8%. I believe decent gains could be possible from current levels, and also rate the stock as a buy.
