The perfect dividend stock needs a special mix of profitability, good cash flow and staying power.
Finding companies like these at the right price isnt easy. For example, ARM Holdings fits the bill, but the high share price and 1% yield means the tech firm isnt much use for anyone who needs a usable income.
Two companies I believe could make the grade are Royal Mail (LSE: RMG) and AstraZeneca (LSE: AZN).
Royal Mail
Royal Mail shares popped 5% higher this morning, after the postal operator increased its cost-cutting target for the year and reported first-half profits in-line with expectations.
Adjusted operating profits excluding transformation costs were down by 6m to 342m. However, underlying operating costs are now expected to fall by 1% this year, versus a previous forecast for flat costs.
The interim dividend has risen by 4.5% to 7p. Analysts expect a total payout of 21.8p this year, giving a forecast yield of 4.5% at the current 480p share price. This should be covered comfortably by forecast earnings of 34.5p per share.
There was good news operationally, too. While letter volumes continue to decline, Royal Mails saw a 4% increase in parcel volumes in its main postal business, along with a 9% increase in volumes in the GLS (Parcelforce) business. This suggests the group may be winning new market share in the all-important online shopping sector.
My only real concern is that the extensive cost cutting being pushed through by chief executive Moya Greene could end up limiting growth potential. In total, 3,000 staff left the business during the first half. The group plans to spend 180m on transformation costs this year, as part of a total investment in the business of 620m. Royal Mail says this is similar to last year.
To justify this kind of expenditure, shareholders will need to see decent growth over the next few years.
Notwithstanding this risk, I believe Royal Mail is an appealing income buy following todays results.
AstraZeneca
When a company receives a takeover offer which then falls through, the share price often drops back to the level it was at before the offer was received.
Interestingly, that hasnt happened with AstraZeneca shares. The current 44 share price is around 15% higher than the 38 level at which Astra shares traded before Pfizer tried to buy the Anglo-Swedish business.
This suggests to me that the market is confident that AstraZenecas pipeline of new products will deliver strong long-term growth. Although profits have fallen heavily since 2011, I believe this long-term view is correct.
Earnings are expected to rise by 11% to $4.25 per share this year, giving a forecast P/E of 16. The dividend is likely to remain unchanged again, but given the 4.1% yield I can accept that for a few years.
One of the things I like most about AstraZeneca is its strong balance sheet. Net debt remains relatively low, at $6.4bn, giving net gearing of only 36%. Cash generation is good, too. On average, the dividend has been covered by free cash flow every year since at least 2009.
AstraZeneca is one of star fund manager Neil Woodfords biggest holdings. I can see why. For long-term income and growth, I believe these shares are a strong buy.
If you already own shares in AstraZeneca or Royal Mail and are looking for more big cap income ideas, I’d strongly recommend a look at “5 Shares To Retire On“.
The Fool’s top stock analysts have selected five blue chip stocks they believe have the potential to deliver long-term income growth.
Unfortunately, neither Royal Mail nor AstraZeneca made the grade. Neither company is included in this report.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended AstraZeneca and ARM Holdings. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
