Mega-cap tech companies have become firmly established as the cheerleaders of the US stock market.
When it comes to paying dividends however, these companies typically have low yields. That’s done little to dampen investor enthusiasm in comparison to higher-yielding American companies.
But with interest rates forecast to fall further, there’s scope for sentiment to brighten stocks with more of an income bias.
Here are three income-paying share ideas that could benefit.
This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Investments and any income from them will rise and fall in value, so you could get back less than you invest. Remember, yields are variable, and no income is ever guaranteed. Ratios also shouldn’t be looked at on their own.
Investing in an individual company isn’t right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you’re investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.
Coca-Cola
What separates Coca-Cola from most of its peers is its operating model.
Coca-Cola doesn’t actually bottle the drinks itself. Instead, it offloads this task to local bottling plants already established in the region. This allows the group to keep a lid on costs and supports its industry-leading gross margins, which hover around the 60% mark.
The interests of both parties are aligned by the group owning minority stakes in these bottling plants, typically between 20-25%. So, when the bottlers do well, so does Coca-Cola.
This structure frees up more cash for Coca-Cola to outspend its peers on marketing, which helps drive revenue growth for bottlers. And because bottlers don’t need to spend on marketing, they can invest more into upgrading machinery and digitising sales teams to help support best-in-class execution.
The split-role structure makes it very difficult for competitors to challenge Coca-Cola’s dominance. As a result, revenue growth has held up much better than many of its peers in recent years.
Getting the right brand at the right price is a difficult task. And even if Coca-Cola pulls it off, it will likely need to invest for several years to ramp up production and elevate brand awareness among consumers.
Coca-Cola might not have the highest dividend yield in the world, at 2.9%. But after increasing dividend payments for 62 years in a row, Coca-Cola has truly earned its crown as a ‘Dividend King’.
These dividends are underpinned by a strong balance sheet and healthy free cash flows.
The valuation’s sitting slightly above its long-run average. We think this highlights the strengths of the brand, and over the long term, we expect this to be more than justified.
But investors should remember, just like any investment, Coca-Cola isn’t immune to price falls, especially in the short term.
Kinder Morgan
Kinder Morgan is a major player in the energy infrastructure industry, owning or operating an enormous network of gas pipelines and terminals in North America. The facilities also handle a wide range of related products.
We believe the group is exposed to several structural growth drivers.
Geopolitical tensions over recent years have been driving a renewed focus on energy independence and surety of supply, which we think will continue to drive US export volumes.
Looking ahead, natural gas is emerging as an important part of the energy transition, which is likely to see gas usage rise for the foreseeable future.
And if prices bounce around, Kinder Morgan’s revenues are predominantly volume-based or at fixed rates. That means it’s not overly exposed to short-term commodity price fluctuations. The barriers to entry in this regulated market also provide some comfort.
We’re not alone in noticing these trends and investor sentiment has seen the valuation move towards the top of its peer group, meaning there’s some pressure to deliver. And if gas prices remained depressed for a prolonged period, there’s still a risk to the group’s growth potential.
Despite the upturn in sentiment the shares still offer a healthy yield of around 4.7%, supported by strong free cash flows. At over four times underlying cash profit (EBITDA), net debt is a little higher than we usually like to see. But that comes with the territory of an asset-heavy business.
Reliance on debt does make it sensitive to financing rates. However, if interest rates fall as expected, that could pave the way for improved returns on investment on new projects if capital is used efficiently.
With a backlog of $5.2bn of investment projects including future-facing ventures like carbon capture and renewable biogas, there are some further growth opportunities ahead.
Quest Diagnostics
Quest Diagnostics is one of the US’ biggest providers of laboratory testing services. The pandemic helped drive a step-change in revenue and profitability. That’s been a tough act to follow. But now Quest is returning to growth as it actively targets more market share.
Diagnostic services typically offer a reliable revenue stream. That’s because healthcare services tend to be less susceptible to economic ups and downs, especially when they’re broadly covered by insurance schemes.
The old adage ‘prevention is better than cure’ is also one that healthcare funders take very seriously, so it makes good sense for them to make sure access improves. It’s also a highly-regulated environment, meaning that the threat from new entrants is limited.
Quest has strong market position and leading expertise in advanced diagnostic techniques like genetic sequencing. That means it’s well placed to benefit from structural growth drivers like the ageing population and a drive towards personalised medicine. This should have a long-term benefit on both growth and profitability.
Recent investments in artificial intelligence are aimed at carving out further competitive advantages, such as faster and more accurate diagnoses.
While Quest has a strong record of innovation, there can be no guarantee that these benefits or their financial benefit will materialise. Other risks include political scrutiny.
Quest’s yield of 2% might be modest, but the dividend has grown every year since 2011 at an average rate of 16.6%.
We don’t see the current payout ratio of less than 50% of profits as overly demanding, so that trend could well continue.
A strong financial position also leaves room for further acquisition activity, a lever the group continues to pull on. Takeovers are never without risk, though.
With the valuation close to the long-term average, we see scope for shareholders to benefit if Quest delivers on its medium-term growth targets.
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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.
