Sometimes a share has a high dividend yield but is a value trap. Profits collapse, payouts get cut, and the share price falls in response. But other dividend stocks can turn out to be a real bargain, offering substantial income potential at an attractive price.
Here are a couple of such shares I would buy for my portfolio today if I had spare money to invest.
The asset manager M&G (LSE: MNG) benefits from a brand name that is known to a large number of actual and potential customers. That should be able to help it grow its business in future. I think it could also benefit from long-term growth in demand for financial services.
During the first half of the year, assets under management and administration fell by around 2%. However, that was driven by market conditions pushing down the value of assets. The business saw net inflows of client funds in the first half.
I see that as positive as one of the risks the City had been pricing into the M&G valuation in the past couple of years was an outflow of funds. That is still a risk, but hopefully the positive momentum can continue.
Meanwhile, the M&G share price continues to reflect some investor scepticism in my view. It has fallen 2% over the past year and currently the dividend yield is a juicy 9.6%. That makes it look like a bargain to me, which explains why I hold it in my portfolio.
Another share that has fallen in the past year, but more steeply, is retailer Tesco (LSE: TSCO). The Tesco share price has fallen 16% in 12 months.
Like M&G, Tesco benefits from owning a familiar brand in an industry I expect to see robust demand in the long term. The dividend has been growing strongly in the past couple of years, pushing the yield up to 4.9%.
Shopping for bargains
I see risks for Tesco. Inflation is pushing up the cost of goods, but Tesco may struggle to pass on such rises in full to shoppers who are tightening their belts. That could lead to profit margins falling.
But the UK’s largest retailer is a proven operator. Not only is its brand strong, Tesco benefits from a large store estate and sizeable digital operation. It enjoys economies of scale that can help it make profits even when many other retailers may struggle to do so.
I think the Tesco share price could be a bargain for my portfolio. The company has long-term strengths and an attractive dividend yield. I see more potential for dividend growth in coming years, as the payout remains below what is was before accounting problems surfaced at the retailer in 2014. They have long since been resolved and I expect Tesco to keep a strong position in the UK grocery market for a long time yet.
C Ruane has positions in M&G PLC. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2022