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UK Equity Income – 3 share ideas for dividends

A key attraction to the UK market is dividends. Here are three UK share ideas with strong dividend-paying potential.

Important information - This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment, and pension rules may have changed since then.

It’s no secret that the UK economy has struggled over the past year or two. Inflation’s been running well above the Bank of England’s 2% target, leading to an aggressive set of interest rate hikes.

These rate hikes act to dampen economic growth, and have contributed to a dip in UK company valuations. Because of this, we think now might be a good time for investors to pay more attention to companies closer to home.

The FTSE 100 index is currently trading at 10.1 times earnings, which is good value compared to historic levels and other developed markets. For context, the S&P 500 index, which is representative of the US stock market, trades at around 24.2 times earnings.

Another key attraction to the UK market is dividend-paying potential. It’s filled with mature companies boasting strong dividend cover and the potential for income to grow over the longer term, although of course there are no guarantees. This comes at a time when income from cash deposits looks like it might have peaked or nearing its peak in the current cycle.

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. Ratios also shouldn’t be looked at on their own. Past performance is not a guide to the future.

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.

Lloyds Banking Group

A large part of the investment case for Lloyds is its heavily discounted valuation, which is currently sitting well below its long-run average.

The depressed valuation has pushed the forward dividend yield up to an attractive 7.0%. Backed by a strong balance sheet, we think this creates the potential for further returns from share buybacks too. But remember, no returns are guaranteed and yields are not a reliable indicator of future income.

Lloyds' focus on traditional banking does make it more exposed to the traditional interest rate cycle than others – 73% of total income was from interest at the last count. With its interest income booming over the past year or so because of rising rates, things seem to have peaked.

Mortgages issued over the pandemic are coming up for renewal at less profitable levels too. This has been a headwind heading into 2024 but should tail off towards the end of the year.

The main drawback of Lloyds' business model tends to be the higher-than-average exposure to potential loan defaults. But with no real uptick in arrears, even these have stayed lower than many first thought. That might change, but the economic outlook is starting to show signs of improvement – with unemployment rates holding firm, house prices stabilising and real wages rising.

Lloyds boasts one of the higher quality mortgage portfolios, which we see as more resilient than most peers. There’s also the benefit from the structural hedge to come through – think of this like a bond portfolio that’s set to roll onto better rates in the coming years. This looks set to boost income over the medium term.

We see the group’s depressed valuation as an attractive entry point. Lloyds is our preferred name in the sector, given what looks to us like a stronger operation than some peers. But it’s not immune to economic uncertainty, so be prepared for a bumpy ride.

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Primary Health Properties

Primary Health Properties (PHP) invests in purpose-built doctor’s surgeries with a long track record of delivering results for shareholders. The group’s even earned the right to call itself a dividend aristocrat, now in its 27th consecutive year of dividend increases.

As a REIT (real estate investment trust), PHP must pay out most of its profits as a dividend. That translates to a forward dividend yield of 6.8%. Although, no shareholder returns are guaranteed.

PHP’s asset base is relatively defensive in the context of today’s uncertain macroeconomic environment. Rent collection rates were 99% in both 2021 and 2022, with 2023 rates trending in the same direction.

We think PHP has several features that underpin long-term dividend-paying potential. The NHS backlog and an ageing population means investment in primary care facilities isn't going anywhere.

And, with 89% of the group's rent roll funded by the NHS or its Irish equivalent, we view the group's tenants as lower risk. On last count the average lease length stood at 11 years, meaning rental income should be secure for years to come.

There are reasons to be cautious though.

Loan-to-value (LTV) is high by industry standards and has risen over the past year.

The REIT structure means investors are likely to be asked to fork out extra cash from time to time, especially as debt financing is more expensive because of higher interest rates. And, because REITs have to pay out most of their profits it's difficult for them to fund growth organically.

PHP’s valuation has come down a little over the past 12 months and is now broadly in line with its peer group. The prospective dividend yield is attractive, and with interest rates expected to fall in 2024, the value of the group’s properties could get a welcome boost, although there are no guarantees.

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Taylor Wimpey

With all the uncertainty floating around the UK economy right now, it might seem odd to pick a housebuilder, given their cyclical nature. Rising interest rates, higher inflation, and regulatory challenges have created significant pain for the sector in recent years.

While there are probably further difficulties ahead, there are also early signs that pressure in the sector is easing. Softer inflation figures are coming through, and lenders are becoming more competitive on mortgage rates – both of which improve buyer affordability and have the potential to increase sales rates.

With its valuation currently sitting well below its long-run average, we think Taylor Wimpey is well-placed to benefit when the market finds its feet again.

The group also has a healthy forward dividend yield of 6.5%. With its current dividend policy related to asset value instead of earnings, it means investors could get a base level of dividends even if economic conditions stay difficult. But remember, dividend policies can change without warning, and no dividends are ever guaranteed.

The balance sheet’s in very good shape, possibly one of the strongest in its peer group. With net cash of £678mn on hand, there’s a big cushion there to help smooth any bumps in the road.

But there are still plenty of challenges to navigate.

2023’s operating profit is set to fall roughly 50% from the £907.5mn seen in 2022. That’s led Taylor Wimpey to pull back on new land spending, which we expect to be the case throughout this year.

The sector’s also facing ongoing labour and supply chain challenges, with planning permission disruptions continuing to be a thorn in the group’s side.

All in, the UK housebuilding sector has had a bit of a recovery in late 2023, meaning investors should be focussed on the longer-term outlook. But, the valuation and income-generating potential is still attractive to investors. Given its strong financial position, Taylor Wimpey is one of our preferred names in the sector.

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Next week we’re looking at UK Equity Income funds for potential dividends. Sign up for our fund insight and get it straight to your inbox.

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. 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.

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Written by
Aarin Chiekrie
Aarin Chiekrie
Equity Analyst

Aarin is a member of the Equity Research team. Alongside our other analysts, he provides regular research and analysis on individual companies and wider sectors. Having a keen interest in global economics, he knows how macro-events can impact individual companies.

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Article history
Published: 18th January 2024