At first glance, Shell (LSE: RDSB) and Berkeley (LSE: BKG) are superb income stocks. Thats because the two companies yield 7.3% and 4.8% respectively, which makes them among the highest yielding stocks in the FTSE 100. Looking ahead, such high headline yields could prove to be a positive catalyst for investor sentiment and push the companys share prices higher.
Drilling deeper, though, and both stocks could face significant future problems. In the case of Shell, the price of oil is clearly a major challenge for the company to cope with. Although it has stabilised somewhat in recent months, most industry experts are of the view that a resurgence in the price of black gold is unlikely and that, realistically, further falls cannot be ruled out. Any such falls could compromise Shells earnings outlook and put its dividend under pressure.
Of course, Shells dividends are already expected to exceed its profit. In the current financial year, for example, Shell is due to pay out 123.1p as a dividend, while earnings per share are forecast to be 119.6p. This undoubtedly makes the companys dividends seem less secure and, with such a high yield, it appears as though the market is pricing in a cut moving forward.
However, with bottom line growth of 9% pencilled in for next year, Shell is set to cover shareholder payouts 1.05 times by profit in 2016. Although still a low number, it indicates that a future dividend cut would not necessarily be savage and is therefore likely to leave the companys shares still being hugely attractive as an income play. And, with Shell adapting its strategy to a world of low oil prices and buying undervalued assets, it appears to be well-positioned to drive profitability upwards in the long run.
Meanwhile, the new curbs on buy-to-let investors are likely to hurt demand for Berkeleys prime properties. This caused the companys shares to fall heavily following the Chancellors announcement of a 3% surcharge on second homes and buy-to-lets in last weeks autumn statement but, at the time of writing, almost all of that fall has now been recovered.
Thats at least partly because Berkeley trades on a super-low valuation. For example, it has a price to earnings (P/E) ratio of only 12.9 and, with its bottom line forecast to rise by 53% next year, its rating is due to fall to just 8.4. This indicates that share price growth is very much on the cards, with low interest rates likely to keep demand from owner-occupiers relatively high over the medium to long term.
And, with the supply of housing unlikely to increase dramatically in 2016 and beyond, it appears as though a favourable demand/supply position will remain for house builders such as Berkeley. Therefore, although its future progress may not be quite as strong as it has been in previous years (where Berkeley has posted annualised earnings growth of 35% in the last five years), it still appears to merit purchase as a long term income play.
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Peter Stephens owns shares of Berkeley Group Holdings and Royal Dutch Shell. The Motley Fool UK has recommended Berkeley Group 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.