It’s perhaps surprising that even with inflation set to rise, dividend stocks remain relatively unpopular. It’s quite straightforward to find high quality stocks yielding 4% or more, which should provide a real-terms return even if inflation moves significantly higher. Here are two prime examples that are likely to become more in-demand over the medium term.
Dividend growth potential
Last week’s decision by OPEC to cut production is likely to improve the performance of the oil industry. The price of oil should rise in future, which means that oil producers are set to generate higher profitability. This should lead to greater investment and more capital expenditure, which will benefit oil and gas services company Petrofac (LSE: PFC).
It yields 6.5% from a dividend covered over 1.4 times by profit. This indicates that there’s sufficient headroom given the uncertain nature of the industry in which it operates. Looking ahead to next year, Petrofac is expected to grow its bottom line by 32%, which means that dividends are due to be covered 1.8 times by profit. This means that even if investment within the oil sector is low, or the oil price comes under pressure, Petrofac’s dividend payments should remain affordable.
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Clearly, it’s not a particularly stable business and investors in Petrofac are likely to experience relatively high volatility. In fact, it has a beta of 1.45. However, in the long run it’s likely to offer high dividend growth alongside a stellar yield.
Inflation-beating potential
As mentioned, inflation is forecast to rise in 2017 and beyond. Various forecasts exist, but a level between 3% and 4% seems relatively likely. This is mostly due to the weakness of the pound, which has made imports more expensive. While retailers in the UK will be able to cut costs in order to absorb some of the additional input costs, over time this will become impossible and consumers will be forced to pay a higher price for goods and services.
National Grid (LSE: NG) aims to increase shareholder payouts by at least as much as inflation over the medium term and therefore has huge appeal. This should ensure that the company’s 4.9% yield remains intact on a real terms basis and could mean that its popularity increases.
Since National Grid trades on a price-to-earnings (P/E) ratio of 14.2, there’s scope for an upward re-rating. This could take place if uncertainty builds in 2017, with the challenges posed by Brexit and the programme of change discussed by Donald Trump likely to cause a more risk-averse approach from many investors.
Although National Grid may not offer the growth potential of Petrofac and other high-yielders, it’s a much lower risk option. Therefore, it’s a strong buy for investors who require an inflation-beating income and who prefer to have a degree of stability in their portfolios for the coming months.
