Do you like a fat dividend? What about a growing dividend? And a company with a legalized monopoly that can keep those fat payouts climbing? Then I think you're going to love this outstanding stock, which I've been buying for my own portfolio in the past few months.
OK, I'm not buying it as of this minute, because of the Fool's disclosure rules, but as soon as the Fool's rules permit, I will be scooping up more. That stock is National Grid (NYSE: NGG ) . There's a lot to like about this regulated utility, and it can make a great investment in times of uncertainty such as we have today.
Another dividend play for a lifetime
Last year I called McDonald's (NYSE: MCD ) the dividend stock for a lifetime. It has everything you could want in a dividend stock: a redoubtable franchise, an above-average and quickly growing payout, a commitment to distribute all of its free cash flow, and even a pile of hidden assets. But I think National Grid could be an even better dividend play.
National Grid is not your typical utility. It operates power and gas transmission systems in the U.K. and the U.S., with about half of its revenue coming from either. It gets paid when electricity or gas moves through its transmission infrastructure, and doesn't generate power itself (with the exception of a few Long Island power plants). So it operates like a regulated toll road, providing income investors an annuity-like stream of cash year after year. And have I mentioned how big a wad of cash that is? Currently, National Grid sports a yield of 7%.
With such invaluable infrastructure assets, National Grid offers a lot of safety to investors. Its hard assets are indispensable and provide a backstop to the company's valuation. In any type of economic climate, National Grid will be in demand. As a regulated utility, this company can lock in a return on its investment, meaning that its payouts grow over time. Dividend growth and sustainability are exactly what income investors need to be looking for. Management has promised 8% dividend growth for the next two years. I like that kind of visibility.
21 years is a long head start
In detailing his outstanding dividend portfolio, my colleague Jeremy Phillips states, "I believe dividend growth, much more than current yield, is critical to a successful dividend portfolio." He's picked some superstar dividend stocks, but I think a high current and sustainable yield is every bit as important as growth. Let me show you why.
For example, take National Grid with its 7% yield growing at 8% per year, and a stock like Colgate-Palmolive (NYSE: CL ) paying 2.7% and growing around 13% per year. It will take about 21 years for the low-yielder's payout to catch up with the high-yielder's, despite that high growth rate. To be fair, that doesn't include capital gains, which would likely be better for a Colgate-type stock. Still, if you need current cash flow, you don't want to wait for capital gains, and 21 years is a long head start.
But doesn't this focus on big dividends make me a yield pig? I'd argue no. Consistent demand and reliable returns help ensure that National Grid's dividend is sustainable. As a regulated utility, National Grid earns a guaranteed return on any additional investment. In fact, U.K. regulators allow a higher return than their U.S. counterparts in order to encourage investment. Compare that to stocks in the wireline industry, such as Windstream (NYSE: WIN ) and Frontier Communications (NYSE: FTR ) , which are high-yield favorites. Whereas demand in this sector is inexorably ebbing, National Grid is seeing modestly increasing returns.
And National Grid is not a cyclical dividend play such as mortgage REITs Annaly Capital (NYSE: NLY ) , Chimera Investment, or American Capital Agency, whose gigantic dividend yields (14% and up) depend on a fat interest rate margin. When rates climb, as they ultimately will, these players will have to cut their dividends, and stock prices will come tumbling after. But even these cyclical stocks can play an important role in a well-diversified portfolio. I own Annaly myself. As a dividend investor, you have to be careful to balance a high current yield with growth, and National Grid can offer both.
Where is National Grid's growth?
Last year the company raised billions through a dilutive equity offering, a move that spooked the markets and sent the shares tumbling. The sooner the company can put that newly raised capital to work, the sooner its earnings can improve. The capital will go mostly to bolster U.K. infrastructure, which is decaying so fast that 25% of power systems plants will close during the next 10 years. That focus on the U.K. is good from a return standpoint, since the company has been receiving an effective return on equity of 15%, according to Motley Fool Income Investor advisor James Early. Even better, in the U.K. -- where the company earns 60% of its profit -- its service rates adjust for inflation, so you have a built-in inflation hedge. U.S. electrical infrastructure also is in need of upgrades, and that spells more opportunity.
Foolish bottom line
This low-risk dividend play offers a lot of advantages: some global diversity, the safety of an asset-backed stock, an inflation hedge, and especially that high and growing yield. For Americans owning the stock, the U.K. does not impose a withholding tax, which could be particularly beneficial for those holding National Grid in a tax-advantaged account.
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