Robert Stephens, CFA, discusses the prospects for dividend growth from two high-yielding FTSE 100 stocks.
The law of unintended consequences could prove to be particularly relevant over the coming years. Fiscal and monetary policy stimulus has taken place on an unprecedented scale since the start of the pandemic. It may have aided an economic recovery but could potentially lead to higher inflation over the long run.
As such, buying and holding dividend stocks that can raise shareholder payouts at a brisk pace could become more important than obtaining a high yield in the present. FTSE 100 stocks such as SSE (LON:SSE) and British American Tobacco (LON:BATS) may provide some protection against the prospect of higher inflation due to their dividend policies and business models.
SSE’s 5.5% dividend yield may be an obvious pull for income investors. However, the renewable energy focused business also has a relatively attractive dividend growth plan. It expects to pay dividends per share that rise in line with RPI between now and 2023 as part of a five-year dividend programme. This could prove highly attractive should inflation increase.
The firm’s gradual shift towards renewables appears to have taken place at an opportune moment. The pandemic seems to have further increased the pace of transition from fossil fuels to wind and other cleaner energy assets. The company’s five-year £7.5bn capital expenditure programme may further enhance its long-term growth opportunities, while asset disposals are providing capital that can be reinvested.
Of course, SSE’s financial performance can be relatively volatile – especially when compared to many of its utility peers. For instance, renewables output in the first three quarters of the year was 5% below expectations partly because of prevailing weather conditions.
However, it remains on track to meet earnings guidance for the full year. Its mix of a high yield, dividend growth potential and opportunities within renewables could make it an attractive income stock in the long run.
British American Tobacco
Tobacco stocks were previously popular among income investors. However, changing consumer trends have led to cigarette volume declines and falling share prices for incumbents such as British American Tobacco (BAT).
It now has a dividend yield of 8%, partly as a result of its 35% share price fall in the past five years. It also plans to maintain a dividend payout ratio of 65%, which could mean its shareholder payouts rise at a relatively fast pace in future.
BAT’s tobacco division continues to post resilient growth, as highlighted in its earnings per share increase of 5.5% in 2020. Tobacco products benefit from pricing power that could make them more resilient during periods of economic strain. Meanwhile, the company’s investment in reduced-risk products, such as heated tobacco, may position it for long-term growth as consumers switch to less harmful nicotine products.
Of course, weak investor sentiment towards the tobacco industry could persist as environmental, social and governance (ESG) concerns become more prominent. Furthermore, regulatory changes remain a threat to the company’s future performance.
However, its high yield, dividend growth potential and forward price-earnings ratio of 8 suggest that its risk/reward appeal remains high. It could prove to be an attractive income stock should fiscal and monetary policy stimulus action prompt a period of higher inflation.